In the context of mortgages, what is meant by "prepayment penalty"?

A prepayment penalty refers to a fee that may be charged to a borrower if they pay off their mortgage loan before the scheduled end of the loan term. Lenders may impose this penalty to compensate for the lost interest income that they would have received had the borrower continued making monthly payments for the full term of the loan. This practice is primarily used in fixed-rate mortgages, where borrowers might refinance or sell their homes, thereby paying off the loan earlier than anticipated.

The other options do not accurately describe a prepayment penalty. Charging a fee for making extra payments on a loan is not generally what a prepayment penalty entails; rather, it refers to early repayment of the entire loan balance. A benefit for borrowers who make timely payments also does not capture the essence of prepayment penalties, as timely payments generally reflect regular adherence to the agreed loan terms rather than early payoff penalties. Lastly, while refinancing can incur costs, a prepayment penalty specifically addresses the early payoff of a loan rather than the act of refinancing itself.