Normally, if you prepay your mortgage, you are faced with a penalty of three months interest. Lenders can charge a penalty as you are terminating your loan agreement with them. They expected to make a certain amount of money on the loan over the term of the mortgage, but if you end that early, they will be losing that money, so they get to charge you a penalty. If your penalty is higher than the standard three month interest charge, it is very likely because the Lender is charging you the “interest rate differential” penalty. This penalty is complex and varies from Lender to Lender in its design. Essentially, the Lender imposes a penalty which is equal to the amount it expected to make off of you, less the amount it can make off the next person to whom it loans the money. In other words, this penalty is equal to the amount it loses off you by your early termination of the loan agreement.
