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Prepayment Penalty A lenders charge to the borrower for paying off the loan before the end of the term. It is present in some mortgages, preventing borrowers from rapidly refinancing. To avoid pre-payment penalties you can pay added fees, called points, on your loan. These points are a percentage of your loan amount and are tax deductible. These points may also be less than the actual pre-payment penalty. Some lenders impliment a 3-2-1 pre payment penalty. This is usually the more cost effective method for the borrower if they needed to pay the mortgage off early. If you select an Adjustable Rate Mortgage (ARM) and you have a Prepayment Penalty (PPP) longer than your initial fixed term of your loan, beware! For example, if you have a 2 year ARM that means that your rate is fixed for that first 2 year period. After that it can adjust to where current interest rates are. If you have a PPP that exceeds that 2 year period, you could be stuck with either a steep rise in your payment each time your rate adjusts. Or, you could be faced with paying the penalty to be able to refinance to keep your payment from rising so drastically. Under most circumstances, there will be no pre-payment penalty on conforming, FHA or VA loans. Some prepayment penalties will only apply if you refinance your home within the prepay period, and not if you sell your home. This is generally referred to as a "soft" prepay. Always ask if your loan will have any prepayment penalties included and ask what the difference would be without. In most cases the soft prepay is two months interest The states that prohibit prepayment penalties, still allow federally chartered banks to apply a pre-payment penalty on loans that they fund. You can ask your mortgage professional to stay away from the federally chartered banks, but sometimes those may be the only banks that can close the loan. So if you take a 2 year prepay, and know that you are going to be in the home for another 3 years (minimum), then it wold be worth taking the prepay and the new loan terms. Hard Prepay penalty pertains to a penalty whether you sell or refinance while the soft pre-pay only pertains to a penalty if you refinance. The soft prepay will not affect you if you sell. When obtaining a loan with a pre-payment penalty make sure that the prepayment penalty does not exceed the fixed part of an ARM loan. If you have a 2 year ARM loan then you probably do not want to have a prepayment penalty that lasts for 3 years or even worse 5 years. Usually the longer and larger the prepayment penalty the more generous a lender may be with their rate. Also, if you know you will be moving within the next 2 years make sure your prepayment penalty is no longer than 2 years unless it is a soft pre-pay which will allow you to sell without being penalized. Some states prohibit prepayment penalties. A penalty may or may not apply to repayment resulting from a home sale. If you are 100% sure that you won't be selling your home soon then it may be a good idea to get mortgage financing that includes a prepayment penaly, especially if the lower interest rate in trade is well worth it. Most lenders will allow you to buy-out the pre-payment penalty. The charges will vary among lenders. In order to verify whether or not your loan carries a pre-payment penalty, be sure to look for the Pre-Payment Rider when signing your loan documents at closing. If your loan does carry a penalty, it is required by law that this rider be included with your mortgage documentation and that you sign it. Most pay-option arms come with a pre-payment penalty either a soft or hard pre-pay. Some loans will have a combination of a hard pre-payment penalty and a soft pre-payment penalty. Usually set-up as hard to start, then transitioning to a soft. Most brokers receive significantly less points from Lenders if they have a 1 or 0 year prepayment penalty. If they can 'sell' the 3 year prepayment penalty, they often max out what the lender is willing to rebate them. If you pay off your mortgage before it is due, you may be charged a fee -- this is referred to as a prepayment penalty. Pre-Payment penalties generally enable lenders to offer borrowers lower interest rates for the life of the loan, so if you are going to be in your house longer than 2 years, a pre-payment penalty can prove to be more benficial than the word "penalty" would indicate, resulting in large savings over the long term, especially on fixed rate loans. Prepayment penalties on a loan offering can change the rate you pay for your mortgage. Many times you can pay a higher rate to reduce your prepayment penalty with that lender. This is one of many reasons why different mortgage brokers quotes may vary with the same borrower information. Prepayment Penalty can be used as a tax write-off at the end of your current year. Please advise your tax consultant in regards to laws and guidelines. He/she may help you recoup the costs if you should break the contract between you and your bank. Paying a prepayment penalty on some types of loans can carry a lower interest rate than not having one. If you feel certain that you will be remaining in the home for a period that exceeds the length of the penalty it may be a wise decision to go with the lower rate. Many of today’s loans come with prepayment penalties. Typically, a prepayment penalty is charged if the borrower repays the loan within the first 2-3 years. This payment is usually equal to six months interest. If you are just a few months out from the expiration of your penalty period, you may want to wait it out before refinancing. However, even with a penalty the long term savings of locking in a lower fixed rate today could more than cover the penalty. Depending on the state you live in and whether your loan was originated as a purchase transaction or a refinance, some states do not allow Pre-Payment Penalties (PPP) imposed on pre-paying a loan that was originated as a purchase. Others have laws that limit the number of years in a Pre Payment period for different transaction types.
Most banks let you pre-pay up to 20% of the outstanding balance without subjecting you to a PPP.
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Information listed above is to be used for educational purposes only and is not guaranteed
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