What is a “prepayment penalty”?
It is costly to originate and purchase a loan. If a loan pays off early, there is no chance for the lender to be repaid for those costs. Prepayment penalties are interest funds paid to the lender if a loan is retired before the term agreed upon in the loan documents. Generally, prepayment penalty clauses apply during the first 3 to 5 years only and there is no penalty thereafter. Prepayment penalty terms vary and may be defined either in your Note or a Rider or Addendum to the Note. One of the most common prepayment penalties assesses 6 months of interest on the unpaid principal balance for a specified number of years after closing. Others charge a flat percentage of the unpaid principal balance during the first years of the loan.
A prepayment penalty is a fee that a borrower must pay when a mortgage loan is paid off early. Either a percentage of the amount is prepaid or a number of months of interest on the amount prepaid. Not all mortgage loans come with prepayment penalties. Prepayment penalties are not allowed on FHA or VA loans. A loan that has a prepayment penalty may have a lower interest rate.
