When a prepayment is made that is less than the full amount to completely pay off the loan, what happens to future monthly mortgage payments for a fixed-rate mortgage loan?

Question

What will be an ideal response?

Answer 1

Homeowners often repay all or part of their mortgage balance prior to the scheduled maturity date. The amount of the payment made in excess of the monthly mortgage payment is called a prepayment. This type of prepayment in which the entire mortgage balance is not paid off is called a partial payment or curtailment. When a curtailment is made, the loan is not recast. Instead, the borrower continues to make the same monthly mortgage payment. The effect of the prepayment is that more of the subsequent monthly mortgage payment is applied to the principal. The net effect of the prepayment is that the loan is paid off faster than the scheduled maturity date. That is, the maturity of the loan is "curtailed." More details are the types prepayments are given below.
The more common type of prepayment is one where the entire mortgage balance is paid off. All mortgage loans have a "due on sale" clause, which means that the remaining balance of the loan must be paid when the house is sold. Existing mortgages can also be refinanced by the obligor if the prevailing level of mortgage rates declines or if a more attractive financing vehicle is proposed to them.

Effectively, the borrower's right to prepay a loan in whole or in part without a penalty is a called an option. A mortgage design that mitigates the borrower's right to prepay is the prepayment penalty mortgage. This mortgage design imposes penalties if borrowers prepay. The penalties are designed to discourage refinancing activity and require a fee to be paid if the loan is prepaid within a certain amount of time after funding. The laws and regulations governing the imposition of prepayment penalties are established at the federal and state levels. Usually, the applicable laws for fixed-rate mortgages are specified at the state level. There are states that do not permit prepayment penalties on fixed-rate mortgages with a first lien. There are states that do permit prepayment penalties but restrict the type of penalty.