Did you know that 40% of all American households own their homes outright? This means no more monthly mortgage payments, no more being charged interest, and a sense of full ownership and freedom.
Isn’t that the dream? If you aren’t able to purchase a property in cash, paying off your mortgage early is the second-best option.
However, there’s a catch. Some mortgage loans include something called a “mortgage prepayment penalty,” which actually means that you could be charged a fee if you were to overpay your mortgage.
Understanding what mortgage prepayment penalty fees are and how they work is important before you take out a home loan. Let’s take a look at what you need to know.
What Is a Mortgage Prepayment Penalty?
Some lenders charge a fee known as a mortgage prepayment penalty or an “early payoff penalty.” This fee is charged when you pay off either all or part of your mortgage loan early.
This fee basically incentivizes borrowers to pay the principal on their loan off slowly over the full term. This is desirable for mortgage lenders because it means that they will be able to collect the maximum amount of interest on the loan.
This fee isn’t necessarily charged if you make a couple of additional payments occasionally. It is common for lenders to allow payment of up to 20% of the balance of the loan every year. A mortgage prepayment penalty typically becomes applicable when a property is sold, refinanced, or if homeowners are paying off a large amount of their mortgage loan at once.
Why Do Lenders Charge Mortgage Prepayment Penalty Fees?
When a lender loans you money to buy a house, they are taking on a large risk. The highest risk period of time for the lender is the first few years of the loan term. This is because the borrower hasn’t put very much money towards the cost of the house compared to its value.
For this reason, you are charged interest on your loan. Interest is a way that lenders can help to protect themselves from financial loss. If you are able to turn around and pay off the principal of your loan immediately, then the lender isn’t able to receive the interest fees that incentivized them to give you a mortgage loan in the first place.
When a lender includes a mortgage penalty, it usually means that they will do so as a way to market lower interest rates. This is because they know that, over the life of the loan, they’ll be able to make up the difference. If you were to pay off your mortgage early, then they will be able to recoup their costs through this prepayment penalty.
How Are Prepayment Penalties Determined?
How much a prepayment penalty is going to cost you depends on a number of different facts that the lender takes into consideration. Some lenders might use a set number of month’s worth of interest on the loan as a reference for the fee, while others might charge a small percentage of the remaining balance on the loan.
How much a lender charges for prepayment penalties can also depend on how quickly the loan was paid off. If the loan was paid off over the course of a few years, it might be lower than if the borrower pays off the mortgage in the first year.
How Can I Avoid Mortgage Prepayment Penalty Fees?
The easiest way to avoid mortgage prepayment penalties is by choosing a lender that doesn’t charge this fee. When you are shopping around for lenders, whether you’re buying your first home or refinancing, you can ask them about their prepayment penalty policy.
Some lenders might have a prepayment penalty that only applies for the first few years or a loan, while others might have a policy that has a penalty for the entire loan term.
You’ll also want to ask about what percentage of the loan amount the penalty usually amounts to. This can help you to determine whether or not the prepayment penalty will end up negatively affecting you and whether it counteracts the other appealing aspects of the loan agreement.
Prepayment penalties are not allowed in all US states. However, some banks might actually not be regulated by state law but instead by federal law. That means that even if you’re in a state that doesn’t allow these fees, you’ll still want to ask your potential lender about their policy.
Are You Looking For a Home Loan in the Salt Lake City Area?
At first glance, a mortgage prepayment penalty might seem like an unfair fee. After all, shouldn’t it be a good thing that you’re paying your loan back sooner rather than later?
However, once you look into why lenders charge these fees, it does start to make a bit more sense. That being said, having a mortgage doesn’t necessarily mean signing on to paying mortgage prepayment penalty fees if you end up being able to pay off your home loan quicker than expected. What it does mean is that it’s important to shop around when you’re looking for a home loan and be sure to ask about different lenders’ policies on prepayment fees.
At Robus Mortgage, we handle all types of residential loans. This means that even if you’ve been turned down by a big lender or a bank, we just might be able to help you out. If you’re looking for a home loan in the Salt Lake City Area, you can get a quote from us today!