When you buy a home, what is the first thing that comes into your mind? It may be related to family or the question about paying the mortgage as soon as possible. Is not it. You do not want to spend 30 years mortgage rates or 15 years mortgage rates.
Then you begin paying the mortgage. You want to finish it sooner. Then you came to know about a term called “Prepayment Penalty.” It is natural for a borrower to get curious about the phrase because, after all, why the lender would charge you when you are paying the entire mortgage sooner than expected.
Well, don’t be surprised because many of the mortgages come with the prepayment penalty. So, when you are looking for a mortgage, you should look out for this term. Every mortgage you choose, make sure to learn about the penalties. So, today we will tell you about the prepayment penalty. What is it? Why lenders charge it?and other essential things about it. Now, let’s get started.
What is the prepayment penalty?
When you are ready to pay all of your mortgage or some part of it in one go, a lender will charge a fee called ‘prepayment penalty.’ The penalty fee is a kind of incentive for the borrower who wants to pay back the mortgage amount. It allows lenders to get interested.
However, do not think that if you made a payment here and there, the lender would charge you. The majority of the lenders charge it when you try to refinance—or Paying off large about the loan or selling the property. This is the reason several lenders will have a mortgage penalty in the contract.
They know they will make it back either in the prepayment penalty or in preparing the money in the long way. It also helps them market the lower rate of interest.
What will you pay?
The cost will vary depending upon a lot of factors. However, you could determine the factors via these points.
- The first thing a lender will check the percentage of the remaining outstanding loan amount. It could be 2% of the remaining loan amount if the payoff is made within the first or third year of the term.
- What is the monthly interest? If you have to pay a total number of months’ interest, there will be a charge. For example, if you spent 6 months interest rate together, you will be charged. It won’t matter whether it was 30 year mortgages rates or 15 years.
- There is another famous model called Sliding scale based on the mortgage term. It is simple. If the mortgage is paid off during the first year, the penalty is 2% If the mortgage is paid during the 2nd year, then the death will be 1%.
How do you check if there is a prepayment clause?
First, you should get the fine print of the contract. You will have to find if there is a prepayment clause. After it, you will have to check how the term is interpreting.
It is required to disclose the monthly fee, any charges, or the prepayment penalties. As we said, get the fine print of the contract and read it. You will find every term mentioned. If you do not see it, it is better to ask the lender about it. They will show wherein the paperwork the clause is located.
There are some loans where the prepayment penalty is illegal. They are:
- VA loans
- USDA loans
- FHA loans
- Personal loan or student loan
The types of prepayment penalties
There are two types of prepayment penalties. We have already said, paying a few extra payments won’t trigger the death. However, It is essential to know when it will happen.
- First, there is a soft, prepay penalty. It means you could sell your home without paying the penalty. It happens when you refinance the house or spend a considerable amount of the mortgage early in the loan term.
- A hard penalty will be applied if you sell the home plus the things mentioned above.
A prepayment penalty usually covers the first years of the mortgage because it is the riskiest for a lender. So, if you want to prepay in these initial years, there will be a penalty.
Should you sign for it?
You can’t be sure about the situation in the future. Whether you will sell the home or get a refinance. It is a hard question. However, you could determine it by asking these questions.
- If you know that you are staying in the home for a long time, it won’t affect you.
- If your mortgage is for a very long term, then you have to choose a lender who won’t charge the prepayment penalty in case something happens.
So, this is everything you needed to know about the prepayment penalty. In case you need help, feel free to contact us. We would be happy to help you.
