A prepayment penalty is a clause in a loan stating that, if the loan is paid early, the borrower must pay a penalty. Such prepayment penalties are most often triggered by the sale of the property, or by the refinance of the loan.
In California, Business & Professions Code Section 10242.6 limits prepayment penalties. The statute applies only to owner-occupied single family dwellings; it does not limit prepayment penalties upon other types of loans. The law limits prepayment penalties as follows:
First, they may be charged only for the first seven years of a loan. After seven years, no prepayment penalties are permitted.
Second, an amount up to 20% of the remaining balance of the loan may be paid, without penalty, in any 12 month period.
Third, if more than 20% of the loan is prepaid in a 12-month period, prior to seven years into the loan, then a prepayment penalty is permitted, but it may not exceed six months of interest on the amount pre-paid, which is in excess of 20% of the loan.