A prepayment penalty is usually specified in a clause in a mortgage contract stating that a penalty will be assessed if the borrower significantly pays down or pays off the mortgage before term, usually within the first three years of committing to the loan. The penalty is sometimes based on a percentage of the remaining mortgage balance, or it can be a certain number of months’ worth of interest. Prepayment penalties protect the lender against the financial loss of interest income that would otherwise have been paid over time.