As with any financial contract, you should read the fine print. In this case, you’ll want to find out if there is a prepayment penalty clause in your mortgage contract and how to interpret the consequences of triggering the fee.
Check For A Loan Prepayment Clause
The law requires lenders to disclose prepayment penalties, along with monthly payments, fees and other loan details. As mentioned, you’ll want to read the “fine print” – in this case, the Loan Estimate or the paperwork that you’ll sign at closing – where you’ll find it mentioned prominently in the addendums and/or disclosure documents with all the other terms of your mortgage loan.
It’s perfectly fine to ask your lender if they charge a prepayment penalty; if they do, ask them to show where in the paperwork you would find the details. If you already have a loan, you can look at your monthly billing statement, as it should be outlined in there.
There are some instances where prepayment penalties are illegal. These include:
- Federal Housing Administration (FHA) loans
- Department of Veterans Affairs (VA) loans
- United States Department of Agriculture (USDA) loans
- Student loans (It’s true that these loans aren’t mortgages, but it’s still good bonus info to know.)
Learn What Will And Won’t Trigger The Prepayment Fee
As we mentioned, making a few extra payments is not going to cause the prepayment penalty fee to kick in. But there are other times that you should be aware of when it will.
Penalties usually cover the first few years of a loan, because those are the riskiest for the lender. If you refinance in the early stages of your loan term, you’ll trigger the prepayment penalty. The amount of the fee will differ based on the type of penalty fee that’s included in your mortgage contract. See the above models for an example of what that could be.
As you’re reading through your Loan Estimate and contract, be aware of the type of prepayment penalty that comes with your loan, just in case something happens and you decide to refinance and/or sell. If you’re unsure, ask your mortgage lender before signing the paperwork and ask them to walk you through the math as it applies to your type of prepayment penalty, your loan amount, your amortization and your interest rate.
FAQs
You may trigger a prepayment penalty if you sell your home, refinance your mortgage early in the loan term, zero the balance of your loan or make a significant lump-sum payment (typically, 20% of your loan balance or more). This penalty isn't usually assessed if you make a few extra payments a year.
How to avoid prepayment penalty? ›
They can also choose not to charge this fee on conventional loans, so it makes sense to take out a loan from a lender that doesn't impose the penalty. Another way to avoid prepayment penalties is by holding off on refinancing or selling your home until the prepayment penalty period — usually three years — has passed.
What is a prepayment penalty? ›
What Is A Prepayment Penalty? A mortgage prepayment penalty is a fee that some lenders charge when you pay all or part of your mortgage loan off early. The penalty fee is an incentive for borrowers to pay back their principal slowly over a longer term, allowing mortgage lenders to collect interest.
What is a reason a lender might charge a prepayment penalty? ›
Prepayment penalties are written into mortgage contracts by lenders to compensate for prepayment risk, particularly in difficult economic climates and under circ*mstances where the incentive for a borrower to refinance a subprime mortgage is high.
How do I know if my auto loan has a prepayment penalty? ›
Checking for a prepayment penalty in an existing contract
If you already have an auto loan that you'd like to pay off early, check your contract to see whether it contains a prepayment penalty clause. You can also check your state law to see whether it's prohibited.
What states don't allow prepayment penalties? ›
Most states allow lenders to impose a fee if borrowers pay off mortgages before a specific date – typically in the first three years after taking out a mortgage. While Alaska, Virginia, Iowa, Maryland, New Mexico, and Vermont have banned prepayment penalties, other states allow them with certain conditions.
Which bank does not charge prepayment penalty? ›
However, there are banks that don't charge a prepayment penalty. Some banks such as State Bank of India, Bank of Baroda, Bank of India, Federal Bank and Canara Bank don't charge a prepayment penalty, whereas banks such as HDFC Bank Ltd, Axis Bank Ltd and ICICI Bank Ltd charge prepayment penalty on car loans.
Who benefits from a prepayment penalty? ›
The lender penalizes earlier prepayment to a greater extent than later prepayment. 12 The penalty benefits the lender because it makes prepay- ment less likely even in the face of lower interest rates.
What is an example of a prepayment? ›
Some examples of prepayment include: Purchasing goods or services as prepaid assets: you might purchase office supplies in bulk, for instance, and pay for them upfront. Repaying the interest on a business loan: you might take out a loan, and make an upfront payment to cover the first few months' worth of interest.
What mortgage does not allow a prepayment penalty? ›
Some mortgages — like FHA, VA and USDA loans — aren't permitted to have prepayment penalties at all, and even when this fee is allowed, it may only be charged within the first three years of repayment.
Types Of Loans That May Include A Prepayment Penalty Clause
- Conventional loans.
- SBA loans.
- Investment property loans.
- Large non-recourse loans.
- Loans from alternative providers.
- Subprime mortgages.
As such, prepayment risk is the risk that the borrower repays the outstanding principal amount (or a portion of the outstanding principal amount) prematurely and, in turn, causes the lender to receive less in interest payments.
Can I pay off my mortgage early without penalty? ›
Typically, loans older than three years are not subject to this type of penalty. If your mortgage is less than three years old, you might have to pay a prepayment penalty to pay it off in full, depending on what your loan contract states.
What are examples of prepayment penalties? ›
This fee is typically structured as a percentage of the remaining loan balance. For example, a loan might have a fixed prepayment penalty of 3%. In this situation, the borrower would have to pay back the remaining balance plus 3% of the same if they wanted to pay off the loan in full.
Can you prepay a car loan without penalty? ›
Not all states allow prepayment penalties — and no lender can charge one on a loan term over 60 months. But if your contract already has one, there are ways to work around it. Start by getting in touch with your lender and asking for payments to be applied differently. If that doesn't work, consider refinancing.
What happens if I pay an extra $100 a month on my car loan? ›
Keep in mind that your actual monthly car payment won't change even if you pay extra for a period of time. You'll just repay the loan sooner and save some interest.
How to avoid paying early repayment fees on a mortgage? ›
How to avoid paying an early repayment charge
- Get a mortgage without charges. Your lender may offer a mortgage deal without early repayment charges – ask about this when agreeing your deal. ...
- Overpay at the right time. ...
- Move lenders at the right time. ...
- Port your mortgage. ...
- Avoiding the Standard Variable Rate.
To mitigate the prepayment risk faced by investors in mortgage-backed securities, prepayment penalties are commonly imposed on homeowners who repay their home loans earlier than expected.
