Sarah has a $400,000 mortgage at a fixed rate of 3.5% with 4 years remaining on a 5-year term. Her mortgage allows a 20% lump sum prepayment annually without penalty. She chooses to make an additional $80,000 lump sum payment this year. What is the likely prepayment penalty for this action?

Question: Sarah has a $400,000 mortgage at a fixed rate of 3.5% with 4 years remaining on a 5-year term. Her mortgage allows a 20% lump sum prepayment annually without penalty. She chooses to make an additional $80,000 lump sum payment this year. What is the likely prepayment penalty for this action?

Answer options:

• A penalty based on the Interest Rate Differential (IRD).
• A penalty equal to 3 months' interest on the $80,000. ✅ No penalty, as the payment is within the allowed lump sum prepayment limit.
• A penalty based on the difference between the 3.5% and the current prime rate.

Correct answer: No penalty, as the payment is within the allowed lump sum prepayment limit.

Explanation: Most fixed-rate mortgages include prepayment privileges that allow for a certain percentage of the original principal (e.g., 10%, 15%, 20%) to be paid off annually without incurring a penalty. Since $80,000 is 20% of the $400,000 original mortgage, it falls within the common allowable limit.