What are Prepayment Penalties?
Whether you’ve recently applied for a mortgage loan or are considering doing so, it’s important to familiarize yourself with prepayment penalties. Prepayment penalties are exactly as they sound; they are penalty fees charged to the borrower for paying off their loan before a certain time period. Generally speaking, the penalties are six months of interest payments, although this varies depending on the lender.
Do all Lenders Charge Prepayment Penalties?
Not all lenders charge prepayment penalties, which is why you’ll want to ask your lender if they do charge these fees, and if so, what the costs are and how they are calculated. NOLA Lending for example, does not generally write loans with prepayment penalties and explains to borrowers how these penalty fees are not a concern on most conventional and government loans.
If there are prepayment penalties however, the lender only charges the penalties if the loan is paid off before the sixth year, more specifically, in the second or third years. The penalties are designed to recoup some of the losses the lender may be faced with since the lender didn’t have time to make up for some of the costs it advanced.
Types of Prepayment Penalties
Prepayment penalties can be “hard” or “soft”. When the prepayment penalty is hard, that means that the fees will be assessed because the homeowner is selling or refinancing the home before the time period is met. When the prepayment penalty is soft, that means that the penalty is forgiven due to other circumstances.
Nevertheless, prepayment penalties can be expensive. Take a $200,000 mortgage loan for example. If you choose to pay off this amount in two to three years, you could be hit with six months of interest at 6 percent, which would come out to an additional $6,000 of penalty fees. Essentially, these fees are what deter homeowners from paying off their loans too soon and therefore, give lenders the time they need to regain their losses.
No matter the case, it’s always important to discuss prepayment penalties with your lender before signing. These penalties should never come as a surprise to the borrower and should be detailed in such documents as the Good Faith Estimate and Federal Truth in Lending. If you have an excellent credit score and are being told by your lender that you will have a prepayment penalty, be sure to get another opinion from a trusted lender.
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