As with any financial contract, you should read the fine print. In this case, you’ll want to find out if there is a prepayment penalty clause in your mortgage contract and how to interpret the consequences of triggering the fee.
Check For A Loan Prepayment Clause
The law requires lenders to disclose prepayment penalties, along with monthly payments, fees and other loan details. As mentioned, you’ll want to read the “fine print” – in this case, the Loan Estimate or the paperwork that you’ll sign at closing – where you’ll find it mentioned prominently in the addendums and/or disclosure documents with all the other terms of your mortgage loan.
It’s perfectly fine to ask your lender if they charge a prepayment penalty; if they do, ask them to show where in the paperwork you would find the details. If you already have a loan, you can look at your monthly billing statement, as it should be outlined in there.
There are some instances where prepayment penalties are illegal. These include:
- Federal Housing Administration (FHA) loans
- Department of Veterans Affairs (VA) loans
- United States Department of Agriculture (USDA) loans
- Student loans (It’s true that these loans aren’t mortgages, but it’s still good bonus info to know.)
Learn What Will And Won’t Trigger The Prepayment Fee
As we mentioned, making a few extra payments is not going to cause the prepayment penalty fee to kick in. But there are other times that you should be aware of when it will.
Penalties usually cover the first few years of a loan, because those are the riskiest for the lender. If you refinance in the early stages of your loan term, you’ll trigger the prepayment penalty. The amount of the fee will differ based on the type of penalty fee that’s included in your mortgage contract. See the above models for an example of what that could be.
As you’re reading through your Loan Estimate and contract, be aware of the type of prepayment penalty that comes with your loan, just in case something happens and you decide to refinance and/or sell. If you’re unsure, ask your mortgage lender before signing the paperwork and ask them to walk you through the math as it applies to your type of prepayment penalty, your loan amount, your amortization and your interest rate.
FAQs
You may trigger a prepayment penalty if you sell your home, refinance your mortgage early in the loan term, zero the balance of your loan or make a significant lump-sum payment (typically, 20% of your loan balance or more). This penalty isn't usually assessed if you make a few extra payments a year.
How to avoid prepayment penalty? ›
They can also choose not to charge this fee on conventional loans, so it makes sense to take out a loan from a lender that doesn't impose the penalty. Another way to avoid prepayment penalties is by holding off on refinancing or selling your home until the prepayment penalty period — usually three years — has passed.
What does prepayment penalty mean? ›
A prepayment penalty is a fee that some lenders charge if you pay off all or part of your mortgage early. If you have a prepayment penalty, you would have agreed to this when you closed on your home. Not all mortgages have a prepayment penalty.
What is a reason a lender might charge a prepayment penalty? ›
Prepayment penalties are written into mortgage contracts by lenders to compensate for prepayment risk, particularly in difficult economic climates and under circ*mstances where the incentive for a borrower to refinance a subprime mortgage is high.
What mortgage does not allow a prepayment penalty? ›
They only apply in certain situations and on certain loan types, For example, lenders legally can't charge prepayment penalties on most government-backed mortgages, including VA loans, USDA loans, and single-family FHA loans.
Can you negotiate prepayment penalty? ›
Negotiate To Remove The Prepayment Clause
You can always try to negotiate having it removed from the contract; ask your lender if they will waive the fee. If they agree, make sure you have it in writing. You can also ask your lender for a quote without the penalty, but remember, that might increase your interest rate.
How do I know if my auto loan has a prepayment penalty? ›
If you're shopping for a car or auto loan, ask your lender or dealer if your contract has a prepayment penalty. You also want to review and double check your Truth in Lending (TILA) disclosures and the contract closely before signing it.
Who benefits from a prepayment penalty? ›
Supporters argue that prepayment penalties are a means of protecting lenders from risks associated with borrowers repaying mortgages early, and so allow lenders to offer more affordable loans with lower interest rates, particularly for the riskiest borrowers.
How to avoid prepayment penalty on personal loan? ›
There are two strategies to potentially avoid the prepayment penalty. Firstly, seek a lender that doesn't impose a penalty for early repayment. Secondly, consider a lender that permits penalty-free loan closure after a certain period within the loan tenure.
What states do not allow prepayment penalties? ›
Most states allow lenders to impose a fee if borrowers pay off mortgages before a specific date – typically in the first three years after taking out a mortgage. While Alaska, Virginia, Iowa, Maryland, New Mexico, and Vermont have banned prepayment penalties, other states allow them with certain conditions.
Types Of Loans That May Include A Prepayment Penalty Clause
- Conventional loans.
- SBA loans.
- Investment property loans.
- Large non-recourse loans.
- Loans from alternative providers.
- Subprime mortgages.
Prepayment penalties make it difficult to pay down the principal or refinance with a different lender. And if your loan has a high interest rate, you'll end up paying a significant amount to your lender without being able to reduce the principal.
Is mortgage prepayment a good idea? ›
As many now realize, mortgage prepayments — which are any amount you pay in addition to your regular payment — will help reduce the overall length of time you hold a mortgage. Even small prepayment amounts can have a big impact on your overall home cost.
How can I avoid prepayment penalty on home loan? ›
Therefore, to avoid an early payment penalty, you should keep room for prepayments when you are planning to take a home loan and calculate the EMI. It will help you to choose the loan type accordingly. For example, by going for a floating interest rate, you can avoid a penalty for paying off mortgage early.
What is an example of a prepayment penalty? ›
Example Of A Prepayment Penalty
An interest-based mortgage prepayment penalty is charged if the loan is paid off within the first 3 years. With 6 months of interest charged, your lender would calculate $250,000 x . 05 = 12,500/12 months = $1,041.66 x 6 months = a fee of $6,250.
What is required for prepayment penalty? ›
A hard prepayment penalty occurs when you sell your home or refinance your mortgage. You aren't able to refinance your loan or put your house on the market without paying penalty fees. You can also incur a prepayment penalty if you attempt to pay off more than 20 percent of your loan balance in any given year.
Can you prepay a car loan without penalty? ›
Not all states allow prepayment penalties — and no lender can charge one on a loan term over 60 months. But if your contract already has one, there are ways to work around it. Start by getting in touch with your lender and asking for payments to be applied differently. If that doesn't work, consider refinancing.
How to avoid paying early repayment fees on a mortgage? ›
How to avoid paying an early repayment charge
- Get a mortgage without charges. Your lender may offer a mortgage deal without early repayment charges – ask about this when agreeing your deal. ...
- Overpay at the right time. ...
- Move lenders at the right time. ...
- Port your mortgage. ...
- Avoiding the Standard Variable Rate.
For instance, Bank of Baroda states that there are no prepayment charges on pre-closure. In case of Federal Bank, there is no prepayment penalty, however the bank charges a penalty in case of pre-closure.
How do you mitigate prepayment risk? ›
To mitigate the prepayment risk faced by investors in mortgage-backed securities, prepayment penalties are commonly imposed on homeowners who repay their home loans earlier than expected.
