Prepayment penalties can be equal to a percentage of a mortgage loan amount or the equivalent of a certain number of monthly interest payments. If you’re paying off your home loan well in advance, those fees can add up quickly. For example, a 3% prepayment penalty on a $250,000 mortgage would cost you $7,500.
A prepayment penalty is a fee that your lender may charge if: you make more than the allowed additional payments toward your mortgage you break your mortgage contract Your lenders may call the prepayment penalty a prepayment charge or breakage cost.
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Prepayment charges are connected to mortgages where the interest term is ‘closed’. The closed term allows for prepayments up to 10% of the original mortgage balance. The prepayment restriction permits you to receive a lower rate than you would normally be able to receive if the term was ‘open’.
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Prepayment penalties are less common on other types of loans, but it’s possible you’ll encounter them at some point. For instance, certain auto loans come with a prepayment penalty clause. Some personal loans do as well, though many personal loan lenders – like Discover, Wells Fargo and Prosper – specifically advertise that they don’t have these fees.
When breaking your mortgage contract early, usually because of a refinance or the sale of your home, you will unfortunately have to pay your lender a penalty called a prepayment penalty. The amount you pay will depend on a variety of factors including the day you signed your original mortgage contract, the term of that contract and your existing mortgage balance, rate type and mortgage rate.
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A prepayment penalty on a mortgage essentially charges you extra if you pay off the mortgage early. What is considered early, however, will be laid out in your loan documents and therefore must be scrutinized carefully. Not all mortgages come with them, and they are certainly not required.
Although most mortgages allow prepayment, there are also tax and penalty considerations. When you prepay, you are in effect investing at the rate of your mortgage. There is no investment risk; however.
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