I have issued 2 mortgages...one with an option to prepay the loan, the other without that option. I want an objective way of calculating the extra interest rate (compared to the second) and prepayment penalty on the first mortgage.
I understand that prepayment option is some kind of embedded option and option pricing theory can be applied here. But I dont have enough background in this, hence looking for a relatively straightforward approach.
Current practice at the bank is to charge no extra interest , and a prepayment penalty= fixed percentage of the amount prepaid.