Mortgage Loan Originator (MLO) Licensing Practice Test

Which statement about prepayment penalties is correct?

1. They are always included in ARMs

2. They are fees charged for repaying debt early

3. They do not exist in government-backed loans

4. They vary by state and are generally not enforceable

The correct answer is: They are fees charged for repaying debt early

Prepayment penalties are indeed fees charged to borrowers for paying off their loan earlier than the agreed-upon term. These penalties are designed to protect lenders from the potential loss of interest income when borrowers refinance or pay off their loans ahead of schedule. By imposing a fee for early repayment, lenders can maintain a degree of financial stability, particularly for loans with fixed interest rates where they would otherwise miss out on future interest payments. While certain loans, such as some adjustable-rate mortgages (ARMs), may or may not include prepayment penalties, stating that they are "always" included in ARMs is incorrect. Additionally, the assertion that prepayment penalties do not exist in government-backed loans is too broad. In fact, while many government-backed loans like those from FHA, VA, and USDA generally discourage or do not allow prepayment penalties, there are exceptions, so this cannot be deemed universally true. The variability of prepayment penalties by state does exist, and there are indeed stricter regulations in some jurisdictions, but this does not mean they are universally unenforceable or not present. Thus, the statement that accurately describes prepayment penalties is that they are fees charged for repaying debt early. This captures the essence of what a prepayment penalty is, providing