Facts about Prepayment Penalty Loan... Prepayment penalty loans generally offer lower interest rates, however if you sell or refinance your home in advance of predetermined loan schedule, you will be penalized. Usually the prepayment penalties for the ARM products would be incurred if you made full or partial payments within the first three years from the date of loan agreement. The prepayment penalty on a fixed rate product would be incurred if you pay off the loan amount early. The penalty varies by product and lender. Generally it is 3% of the loan amount. Some lender will let you pay 3% for the first year, 2% for the second year, and 1% for the third year if the penalty applies to you. Otherwise, regardless of the timing, you have to pay full 3%. The disadvantage of prepayment penalty loan is that even if interest rates go down, you have to keep your loan so you don't end up paying penalty. However, if interest rates go up, you have a favorable rate.