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CONSEQUENCES

Reinvestment risk is the reason why many Mortgage s and other types of loans have Prepayment penalties. When the lender or investor lends the money at 5%, the borrower will most likely continue paying off the loan until interests rates go lower, in which case he would refinance the loan to get a lower rate. In refinancing the loan, he pays back the original lender, but now the original lender must find a new place to put their money. Since rates are lower now, it would be impossible then to make the same loan at five percent. To help compensate for this, many lenders implement some sort of prepayment penalty.