Which type of loans prohibits prepayment penalties?

The correct choice indicates that adjustable rate mortgages (ARMs) prohibit prepayment penalties due to specific regulations governing these loan types. Prepayment penalties are fees that lenders charge borrowers for paying off their loan early, which can be seen as a way to protect the lender's interest and anticipated earnings from the mortgage interest.

Under the rules set forth by the Consumer Financial Protection Bureau (CFPB) and regulations surrounding qualified mortgages, certain loans—including many adjustable rate mortgages—are designed to provide borrowers with more flexibility in paying off the loan early without incurring additional fees. This is particularly important in ARMs, as the interest rate can fluctuate over time, potentially making it more advantageous for borrowers to refinance or pay off the loan if rates rise.

Fixed-rate qualified mortgages, conventional loans, and short-term loans can sometimes include prepayment penalties, depending on the specific terms set by the lender. The prohibition on prepayment penalties in ARMs aligns with consumer protection measures aimed at encouraging responsible borrowing practices and providing greater options for homeowners in managing their mortgage debt.