Are you ready to make a dent in the mortgage balance and pay it off early? That's fantastic! But before you send that payment, there's something important you need to know. It's called a mortgage prepayment penalty fee, and it's a potential snag that could cost you big bucks if you're not careful. Let's break it down.
What is a prepayment penalty?
A mortgage prepayment penalty is a fee charged by some lenders to discourage borrowers from paying off their loans early or making substantial payments before the due date. Typically, this penalty applies within the first few years of the loan term. However, not all mortgages come with this penalty.
You might be wondering why lenders would penalize you for being a responsible borrower and paying off your debt ahead of schedule. Well, it's all about the money for them. Lenders make more money when borrowers stick to the original payment schedule because they collect more interest over time.
Are prepayment penalties common?
Prepayment penalties were more common during the housing market frenzy of the early 2000s, especially with high-risk loans. However, they're not as widespread today. Still, it's essential to carefully review your mortgage agreement to see if this fee applies to you.
What types of mortgages have prepayment penalties?
A prepayment penalty is a charge that a lender might impose if you pay off your home loan earlier than expected. Usually, this fee applies only if you pay off the entire mortgage balance within a specific timeframe, typically the first three years of the loan.
You might face a prepayment penalty if you:
Pay off your loan completely.
Refinance your existing loan by getting a new one.
Sell your home and use the proceeds to pay off the loan.
Since 2014, certain types of mortgages have been prohibited from having prepayment penalties. Government-backed loans like the Federal Housing Administration, Department of Veterans Affairs, and U.S. Department of Agriculture loans cannot have prepayment penalties. Yet, other types, like jumbo mortgages, may still have them
How much can these penalties cost you?
The cost of a prepayment penalty can vary depending on your lender and loan program.
Percentage of remaining loan balance: If you decide to pay off your loan early, like within the first 2 or 3 years, the lender might charge a small percentage, for example, 2%, of the amount you still owe as a penalty fee.
X number of months’ interest: In this scenario, you would pay a certain number of months’ worth of interest upfront, such as the equivalent of 6 months' worth.
Fixed amount: Under this arrangement, the lender sets a specific fee, like $3,000, for paying off the loan within the first year. However, this method is not commonly seen in mortgages.
Sliding scale based on mortgage length: This is the most common approach. For instance, let's say there's a 2/1 prepayment penalty structure over the first 2 years of the loan. If you pay off the mortgage in the first year, the penalty might be 2% of the remaining principal balance. If it's paid off in the second year, the penalty might decrease to 1% of the remaining principal balance.
How do we avoid prepayment penalties?
To avoid getting caught off guard by prepayment penalties, carefully review your mortgage documents before making any extra payments. If you're unsure whether your loan has a prepayment penalty clause, reach out to your lender for clarification.
In conclusion,
While paying off your mortgage early can be a smart financial move, it's essential to be aware of any prepayment penalties that may apply. By understanding the terms of your loan and asking the right questions, you can steer clear of costly surprises and achieve your goal of homeownership without any unnecessary fees.
