Prepayment Penalty

A prepayment penalty is a charge imposed by a mortgage lender on a borrower who wants to pay off part or all of a mortgage loan early. Loans with a prepayment penalty usually have a lower interest rate.

Most states dictate if Pre-Payment Penalty (PPP) is allowed, and if so, the maximum number of years banks can impose PPP on a mortgage.

You should make sure you know what your prepayment penalty is and how long it is for. Some lenders offer a soft prepayment penalty which means you can sell without a penalty and some are hard which means if you sell or refinance you will have to pay the penalty.

In some cases, it may be worth your while to pay the penalty and refinance into a more beneficial loan product. For instance, you may have a adjustable rate mortgage (ARM) that has adjusted to a much higher rate. You need to consult a mortgage loan consultant to counsel you on whether this may be appropriate for your financial situation.

Most pre-payment penalties are calculated as 6 months of pre-paid interest on 80% of the balance of the loan. Interest paid on your home is tax deductible at the end of the year so basically it's a wash. A pre-payment penalty shouldn't stop you from getting a new loan if the benefits outweigh the costs.

PPP’s are typically for periods of two or three years, with five years being the legal limit.

There are two types of prepayment penalties- a HARD prepay and a SOFT prepay.

A hard prepayment penalty is initiated whether you refinance or sell the home within the prepayment period.

And a soft prepayment penalty is only initiated by refinancing, with no penalty for selling the property.

Always ask your broker what type you have and how it will affect your future mortgage plans.

» DISCLAIMER: The information contained in this article on 'Prepayment Penalty' is a collection of contributions by licensed mortgage professionals and is not the opinion of Broker Outpost LLC. Always consult a licensed professional before applying for a mortgage.