What is a mortgage prepayment penalty and how does it work?

What is a mortgage prepayment penalty and how does it work?

A mortgage prepayment penalty is a commission you pay the lender if you to sell, refinance, Where pay off your mortgage within a certain period of time after your initial mortgage closes, usually three to five years.

You probably won’t have to pay a penalty if you pay extra for your mortgage each month, or if you make additional payments here and there. This will likely only be the case if you a) fully pay off the mortgage by making a large payment, selling or refinancing, or b) pay off a large portion of your mortgage in one go.

The terms of your prepayment penalty will be included in the documents that you sign at the closing, but your lender should let you know of the penalties well in advance of that date. If a lender grants a mortgage that includes prepayment penalties, they are also legally obligated to offer you an alternative mortgage that does not levy penalties. If you’re already in the home buying process and your lender hasn’t broached the subject yet, don’t be afraid to ask.

Some mortgages impose stiff penalties and others have soft penalties.

With a severe sentence, you will pay a fee if you sell Where refinance your home. But with a soft penalty, you will only pay if you refinance – you can sell at no additional cost. Again, the details of whether you have a hard or soft penalty should be spelled out in your closing documents.

Does every mortgage have a prepayment penalty?

Legally, lenders cannot impose prepayment penalties on certain types of mortgages. You won’t pay a penalty on most government guaranteed mortgages, including Virginia, USDA, and single family FHA Mortgages.

You could have a prepayment penalty on a conventional mortgage, but remember that your lender is legally obligated to offer you an alternative with no prepayment penalty.

How much is a mortgage prepayment penalty?

Each lender has their own methods of charging mortgage prepayment penalties. Here are some possibilities:

  • Fixed costs: Maybe you would pay $ 500 regardless of when you pay off the mortgage or how much mortgage is left over when you refinance.
  • A percentage of the remaining mortgage when you sell or refinance: Suppose you still owe $ 100,000 when you refinance your home and the prepayment penalty is 4%. You would pay 4% of $ 100,000 or $ 4,000.
  • The interest: For example, you might have to pay six months of interest.

Talk to your lender or view your closing documents for full details of your prepayment penalty.

Why do prepayment penalties exist?

If you pay off your mortgage early, such as a few years after taking out your loan, the lender loses up to tens of thousands of dollars that you would have paid in interest over the years.

If you refinance, you could go through another lender. If you are selling, chances are the buyer is using a different lender. Either way, your current lender would lose money.

A prepayment penalty can discourage you from paying off your mortgage early, so the lender can keep your business. If you pay off the loan early, the lender at least compensates for the loss.

Depending on your situation, you may decide that incurring a prepayment penalty is worth it. For example, if you pay a fixed fee of $ 500 to prepay your mortgage, but save $ 10,000 in interest, you can still choose to do so.