text: Yes, a prepayment penalty is deductible.  It's essentially a payment in lieu of the interest the lender would have earned had you not prepaid.  It's deductible as interest.\n\nFrom the IRS website (pub. 936):\n\nMortgage prepayment penalty.   If you pay off your home mortgage early, you may have to pay a penalty. You can deduct that penalty as home mortgage interest provided the penalty is not for a specific service performed or cost incurred in connection with your mortgage loan.