Prepayment Penalty

Taking into account selling your home, refinancing your mortgage or making extra mortgage payments? Any of these actions might actually trigger a prepayment penalty from your mortgage lender, which could set you back a large number of dollars if you don't watch out.

• What is a prepayment penalty?
• What sorts of mortgages have prepayment punishments?
• How a prepayment penalty functions
• How much are prepayment punishments?
• Types of prepayment punishments
• Illustration of a prepayment penalty
• The most effective method to be aware in the event that your mortgage has a prepayment penalty
• Step by step instructions to keep away from a prepayment penalty

What is a prepayment penalty?

Prepayment penalty definition

A prepayment penalty is a fee charged by a lender to deter a borrower from paying more than their scheduled periodic payment or totally paying off their loan under the terms of the loan agreement.

Fortunately most borrowers aren't subject to a prepayment penalty these days, yet it's important to check whether you're subject to one before you get or refinance a mortgage, list your home available to be purchased or endeavor to early pay off your mortgage.
Mortgage lenders and banks get more cash-flow when you pay off your loan over a more drawn out period, for example, with a 30-year mortgage. That is on the grounds that interest builds over the life of a loan. In the event that you pay off your loan right on time by selling your home, refinancing to another loan or making extra payments toward your principal, the lender will not earn as much on that loan.
"Doing so denies the lender of the expected interest over the term of the loan, and it likewise abbreviates the term of the loan," says Charles Gallagher, an attorney in St. Petersburg, Florida.
"Lenders use prepayment punishments to boost individuals to keep the loan for something beyond a little while," says Kate Bulger, director of business development for Money Management International in Atlanta.

What sorts of mortgages have prepayment punishments?

Luckily, prepayment punishments are more uncommon than they were years prior.
"They're associated with non-adjusting mortgages — loans not sold or insured by government-supported endeavors like Fannie Mae or Freddie Mac — and they don't make a difference to conventional, FHA, VA or USDA home loans," says Anna DeSimone, New York City-based personal finance expert and creator of "Lodging Finance 2020."
DeSimone adds that a prepayment penalty isn't really something terrible. You might have needed to seek after a loan that accompanies a prepayment penalty to get financing. For instance, in the event that you are independently employed and run a small business with under a two-year history required by conventional lenders, you could need to get a non-qualified mortgage that accompanies a prepayment penalty.
Gallagher adds that the Dodd-Frank Act restricts most prepayment punishments for current residential home loans, yet they're actually took into account loans that were executed before Jan. 10, 2014.

How a prepayment penalty functions

The Dodd-Frank Act laid out limitations for prepayment punishments. Today, a mortgage prepayment penalty must be assessed during the initial three years of the loan term. Additionally, the punishments are capped at 2 percent of the loan balance for the initial two years and 1 percent of the loan balance for the third year.
"The penalty is constantly revealed with your mortgage rate quote when you search for a loan," DeSimone says. "Typically, you'll see a statement, for example, 'prepayment penalty fee equivalent to 90 days' interest will be paid in the event the mortgage is terminated in 12 months or less.'"
At the point when you are assessed a prepayment penalty, it will be charged by and paid as a lump-sum fee to the lender. It is assessed upon the refinance or sale of your home and is normally collected from closing proceeds.

How much are prepayment punishments?

In spite of the fact that prepayment punishments are rare today, when applicable, the fee can be steep. The penalty can be 2 percent of your loan balance inside the loan's initial two years and 1 percent of your loan balance in year three.
For instance, suppose you need to sell your home just a single year after you took out a non-adjusting mortgage loan to purchase it. Assume your excess balance is $300,000. At closing, you'll probably be charged a prepayment penalty of $6,000, which amounts to 2 percent.
"Before the Dodd-Frank Act, prepayment punishments were even more terrible — frequently running somewhere in the range of 3 to 5 percent," Gallagher says.

Types of prepayment punishments

There are two types of prepayment punishments: soft and hard.
"A soft prepayment penalty is possibly assessed when you refinance your home. Furthermore, it would adjust to the language of an agreed percentage penalty found in your mortgage loan reports," Gallagher says.
A hard penalty happens when you sell your home or refinance. You can likewise cause a prepayment penalty on the off chance that you endeavor to pay off in excess of 20 percent of your loan balance at whatever year.
"Making a couple of extra payments toward your principal or paying some extra consistently for the most part isn't sufficient to trigger a prepayment penalty," Bulger says.

Illustration of a prepayment penalty

Here is another prepayment penalty scenario. Let's assume you bought a house 19 months prior and borrowed $200,000 by means of a non-adjusting mortgage loan to finance it. Presently, interest rates have dropped a lot of lower, and you need to refinance to bring down your regularly scheduled payments.
"In this case, since you are refinancing inside the initial two years of the loan, you would be charged a $4,000 penalty — comparing to 2 percent of your balance," Bulger says.
Another model: Imagine you acquire a windfall and choose to utilize $30,000 of it to help pay off your $200,000 mortgage all the more rapidly.
"In this scenario, you wouldn't be charged a prepayment penalty," Bulger says. "That is on the grounds that your $30,000 accelerated payment is not exactly the 20 percent maximum your lender will permit yearly as a prepayment amount."

The most effective method to be aware on the off chance that your mortgage has a prepayment penalty

In the event that you don't know whether a prepayment penalty applies to your current mortgage, Bulger suggests calling your mortgage lender or servicer to ask. Another method is to check the fine print on your month to month statement or closing archives.

Step by step instructions to stay away from a prepayment penalty

The best method for staying away from a prepayment penalty is to take a pass on loans that impose the fee.
"Shop the market carefully with more than one lender and ask around about various loan products," Gallagher says. "Demand a loan without a prepayment penalty, and read over the terms of your loan and desk work completely before signing it at closing."
In the event that you learn that you might be subject to a prepayment penalty, figure out every one of the subtleties. Try to time a home sale, refinance or accelerated payment strategy carefully so you can try not to pay any punishments.
"Likewise, call your lender and try to arrange a lower prepayment penalty fee," Bulger says. "They aren't required to bring down the penalty, however in certain conditions they might consent to a lower amount."

Features

• Mortgage lenders are required to unveil prepayment punishments at the hour of closing on another mortgage.
• Prepayment punishments act as protection for lenders against losing interest income.
• A prepayment penalty clause states that a penalty will be assessed assuming the borrower fundamentally pays down or pays off the mortgage, for the most part inside the initial five years of the loan.