Why do prepayment penalty clauses matter?

Let's look at an example of a situation where taking a slightly higher rate for better prepayment terms will save the borrower a lot of money. For the purpose of the calculation, we will be comparing two hypothetical rates of 2.50% and 2.60%. The actual rate is not what is important to this scenario.... it is the difference in the two rates that matters.

Let's say a borrower has a mortgage of $400,000, and they have accrued enough higher interest debt where it will save them a lot of money to increase the mortgage with a refinance to pay off the higher interest debt. Let's also say that the borrower is 2 years into a 5 year term, and the refinance rate at this time is 2.50%.

Both mortgages are non-major bank, or wholesale mortgages (most major banks include posted rates in their penalty calculations, which can cause for much higher penalties).

 While the balance after 2 years in Table A would be $788 less than the balance in Table B due to the lower rate, the difference in the penalties would be $7,909. Therefore for having taken the slightly lower rate with the more severe prepayment penalty clause, the borrower suffers a loss of $7,121