Lenders will often offer their customers a lower rate if they'll agree to accept a "prepayment penalty." They do this to minimize their revenue loss should interest rates decline and the borrower refinances or, in some cases, should the borrower sell the property.

Generally, a payment of up to 20% of the balance is allowed without incurring prepayment penalties. Prepayment penalites frequently are expressed as a percentage of the remaining loan or a number of months of interest. As the lenders gains interest payments over the length of the loan, this penalty usually lessens over time.

Prime borrowers are generally not offered a lower rate in exchange for a prepayment penalty as they have more flexibility in choosing lenders and do not need to restrict themselves. If a lower rate is important to these borrowers, they may need to inquire to the lender if such arrangements are available.

Borrowers with poor credit may be obligated to accept prepayment penalties. This is because the lender wants to tie the borrower to the high interest rate for as long as possible. A person borrowing at 10% is very likely to qualify for a lower rate by improving his credit within a couple of years.

Combined with market-driven refinancing opportunities and the possibility of default, a lender is worried about maintaining the life of the loan and may insist on prepayment penalties.

A borrower in this situation may still have some wiggle room, however: Remember that the lender still wants to have your high-rate business. You may be able to negotiate for partial prepayments (the 20% figure mentioned above is a good goal), a shorter length of time for the penalties to be in effect and/or a reduced penalty percentage.

More middle-of-the-road borrowers should investigate their prepayment options and decide what their goals are for repayment. By committing to a rate for a few years, you might find that you are able to significantly reduce your total bill with a lower rate.

All buyers should know whether the prepayment penalty to which they are agreeing covers repayment only due to financing or if if covers repayment due to sale, as well.