What is Prepayment Penalty?

Prepayment penalties are those charges which a lender imposes if you wish to pay off your loan early. Typically home mortgages are written for 15 or 30 year periods of time. While you may not hold the mortgage for the full term, it is likely that you will probably stay in the property longer than just one or two years.

Loans with a prepayment penalty usually have a lower interest rate. But, in exchange for this lower rate, you'll have to pay a penalty if you pay off the loan early (within the first three years of buying your home). This penalty can be up to 3% of the loan amount.

For this reason, you should carefully read your note and mortgage documents, in particular the prepayment penalty clause to understand conditions which would apply to your loan. The loans which will carry a prepayment penalty often penalize you only for paying off the loan early in the first five years, and thereafter a graduating scale may apply, or there may be no prepayment penalty at all after that initial five year period.

To find out if your loan will have a prepayment penalty you should first look at the type of loan you will be acquiring. Traditional loans with fixed rates of interest usually do carry a prepayment penalty while loans with an adjustable interest rate generally do not carry the prepayment clause. There are some types of home loans which re prohibited by law from charging prepayment penalties. These loans include FHA and VA loans and federally chartered credit union loans. Prepayment penalties are illegal in some states, so you may want to check with your lender or attorney for the laws which apply for your state.

It is best to find out all the details about any prepayment penalty which may apply to your loan before you sign your loan documents. Ask questions, and if there is to be a penalty, ask if the lender would consider waiving the prepayment penalty for you. You never know when your circumstances may change and you may want to pay off or refinance your existing mortgage.

Waiving Prepayment Penalty.

Prepayment Penalty can be waived by refinancing your loan. Refinance will pay off your penalty, thus increasing your new loan amount. In most cases you can wait until penalty expires, example: You have a mortgage with prepayment penalty for 3 years. After those 3 years penalty will no longer be valid, therefore, you can refinance without with ease. If you decide to refinance/sell before penalty is due, you will have to pay off this penalty.