What is a “prepayment penalty”?
Prepayment means paying all or part of a mortgage debt before it is due. This could mean refinancing the mortgage or making substantial payments against the principal. A substantial payment is generally defined as an amount that exceeds 20% of the original principal balance. A mortgage with a prepayment penalty option requires you to pay a penalty or fee if all or most of the loan amount is repaid within a certain time period (generally ranging from 2 to 5 years from the start of the loan). A prepayment penalty option can be found on different types of mortgages, like a 15- or 30-year fixed-rate loan or adjustable rate mortgages.
You may be penalized if you pay off the loan prior to the end of a set term. Some mortgages do have a prepayment penalty, but most do not. It is most commonly found in the “No Cost” loans being offered, where the lender is looking for their profit to come in the form of a higher rate over a period of time.
Although it is illegal or limited in some states, home loans may include a prepayment penalty. This is a charge imposed if the borrower pays off the loan ahead of schedule. This penalty is usually 1 or 2 percent of the loan. It is possible that a home loan will include a prepayment penalty for only the first few years.
Prepayment penalties are interest funds paid to the lender if a loan is paid in full before the term agreed upon in the loan documents. Generally a prepayment penalty clause applies during the first 3 to 5 years and the n expires thereafter. Prepayment penalty terms vary and are defined in the terms of your note and/or rider.
