What is a loan prepayment penalty? If the loan we have been offered has this feature, should it be a red flag to look elsewhere?
A prepayment penalty may be charged by the lender to recover part of the initial costs to originate the loan and some of the interest it planned to earn over the projected life of the mortgage. Today, mortgages typically have a life of five to eight years before they are paid off. Prepayment penalties are most common on adjustable rate mortgages (ARM) because the interest rates offered are lower than on fixed rate mortgages. Most prepayment penalties are in effect for only one to three years. If you are offered a mortgage with a prepayment penalty that is in effect for more than three years, that could be a red flag. Be sure to ask if the mortgage you are being offered has a prepayment penalty. If it does, get a written description of how it works. Some penalties are a percentage of the original balance of your mortgage, while others are based on the balance when you pay off the mortgage. Prepayment penalties can be a fixed percentage for their term, or they may decrease each year. The
