When taking out a home mortgage, it is important for you to understand every aspect of your mortgage, so you know exactly what you are getting yourself into. A prepayment penalty is an aspect of your mortgage that you should definitely be aware of.
Many people that take out a home mortgage look forward to the day when they can pay that mortgage off. In fact, many people try to make extra payments along the way in an effort to pay off their loan amount early. At first thought, the notion of paying off a mortgage early is win-win for both you and the mortgage company. The lender gets their money back and you are able to own your home outright sooner rather than later. Unfortunately, not all mortgages are created equal.
Some mortgage companies will impose a prepayment penalty on borrowers who try to pay off all or part of their loan balance early. Most lenders allow borrowers to pay up to 20 percent of the loan balance each year. Any payments above that 20 percent will cause the borrower to incur penalties. These penalties can cost borrowers thousands of dollars.
Prepayment penalties are often found on loans to at risk borrowers. These borrowers are individuals that have credit problems. Mortgage lenders that offer low interest rates will also use prepayment penalties to recoup some of their profits.
Types of Prepayment Penalties
There are two types of prepayment penalties.
Soft Prepayment Penalty
This penalty is applied when the borrower attempts to refinance a mortgage.
Hard Prepayment Penalty
This penalty is applied to both the sale of a home and a refinancing transaction.
A loan with a prepayment penalty may seem attractive to you initially, because it comes with a low interest rate. However, what you once thought was a good thing will quickly become a bad thing if you seek to refinance your loan earlier than you planned.
Lenders have different approaches towards prepayment penalties. Make sure that you fully understand what you are getting yourself in to. Do your due diligence and have your lender to explain their prepayment disclosure prior to closing.