One of the many things to take into consideration when applying for a mortgage is the fact that, if you plan on paying off your mortgage before the loan term is up, you may have to pay a prepayment penalty. When taking out a mortgage loan, many home buyers tend not to think too far in the future, and so a prepayment penalty clause on the loan contract may go unnoticed at the time of the closing. After a few years, if the home owner decides to refinance or even pay off the mortgage loan, the prepayment penalty may come as a surprise and possibly interfere with his plans.
What is a Prepayment Penalty?
If your mortgage has a prepayment penalty, it means that you will be required to pay a specified penalty to your lender, if you decide on paying off your mortgage earlier than the term that was agreed upon.
In some cases, home owners choose to pay off their loan before the end of its term because they have come across a large amount of money and don’t want to make monthly mortgage payments anymore. But in most cases, home owners choose to prepay their mortgage loan because they have found a better loan from a different lender, with a lower interest rate. Usually, when interest rates decrease, a significant number of home owners choose to refinance, which makes prepayment numbers increase.
If you are not sure if there is a prepayment penalty on your mortgage, the easiest way to find out is by finding the paperwork from when you took out the loan and look for the mortgage note. The mortgage note is a document that promises to repay an amount of money and interest at the specified time, and also includes the prepayment penalty clause.
Prepayment penalties are not necessarily a bad thing. Agreeing to a prepayment penalty can result in a lower interest rate on your loan. Prepayment penalties are bad if you don’t realize that they are included in your mortgage contract at the time of the closing, and end up interfering with your plans and budget in the future.
How Can Paying Off Your Mortgage Early Hurt You?
Some mortgage loans only have short term prepayment penalties, but others have penalties that can be in effect for up to 3 to 5 years. Most people refinance their mortgages before then, so prepayment penalties end up hurting them financially, making the refinance process very expensive, and sometimes even impossible.
There is a type of prepayment penalty called a soft prepayment penalty which only goes into effect if you refinance. You won’t have to pay a penalty if you sell your home, but, unfortunately, most prepayment penalties are the type that will affect both events.
Lowering Your Prepayment Penalty
Prepayment penalties may seem like just a tactic to rob you of some money, but they are legitimate, and will come back to haunt you at the worst of times, if you haven’t been paying attention when you closed on your mortgage loan. Fortunately, there are ways in which this penalty can be lowered.
Check the contract and read the fine print. Find out if there is a prepayment penalty clause in your contract and what it entails. Some prepayment penalties require you to pay a single fee, while others are based on how long you have made payments on your loan. The percent difference between getting out of a mortgage loan after one year or after 4 years translates into thousands of dollars. If you are close to reaching a threshold, then waiting a few months is not a bad idea, and it will save you a significant amount of money.
Contact the lender and start negotiating. You will probably have to speak to a few people before finding the employee who has the power to help you, or at least answer your questions, so don’t give up after talking to the first person who answers. There’s a strong chance that your prepayment penalty will be reduced if you politely present your case and ask for a reduction. Make sure that you make note of everyone you spoke to, and try to get the prepayment penalty reduction in writing.
A prepayment penalty can be a very unpleasant surprise at a time when you have taken some important decisions, like paying off your mortgage loan or refinancing. Making sure that you thoroughly read all the documents required at closing before signing them will save you a lot of trouble in the next several years. Also, remember that prepayment penalties are not a bad choice if you are trying to reduce the cost of your loan. A lower interest rate acquired by agreeing to a prepayment penalty will save you a significant amount of money over time.