Prepayment penalties

Prepayment penalties

Many people do not seem to understand or even know what a prepayment penalty is, whether because it was not well explained or it was not even brought up.  If you are not well informed about this aspect, it can be very costly to you if you happen to break the rules, whether you know it or not. 

A prepayment penalty is a fee that is charged if you pay off your mortgage too quickly either by refinancing, selling, or prepaying before the end of its term.  A prepayment penalty, also known as a prepay, is an agreement between a borrower and a mortgage lender that regulates what the borrower is allowed to pay off and when. 

Most mortgage lenders allow borrowers to pay off up to 20 percent of the loan balance each year. Due to the fact that a mortgage lender earns income through the interest you pay, they lose income if you pay off the mortgage prior to its maturity date. Hence the inclusion of a prepayment penalty in many mortgages. However, not all mortgage loans have a prepayment penalty. 

How do you calculate prepayment penalties? 

There are two ways to go about doing this. The penalty is usually greater of three months interest, based upon the current mortgage loan balance, or the interest rate differential, which is the difference between how much you would pay with your original mortgage interest rate and how much you would pay based on interest rate that the lender can charge today.

Important to know is the fact that prepayment penalties are found most commonly on fixed rate mortgages with a closed term while variable rate mortgages, if there is a prepayment penalty, will only charge the three months interest.  HELOCs don’t charge prepayment penalties.

If you have questions, we can assist you in determining what your prepayment penalty would be if you choose to refinance, based upon current market mortgage rates.  We will assist you in finding ways to lessen a prepayment penalty, and determine whether it would be beneficial to you to refinance with a prepayment penalty.