Mortgage Pre Payment Penalties

Add this topic to the list of things that I over look when explaining things to my clients and people on the forums. Pre payment penalties play an important role in your decision making when it comes to finding the right mortgage. Here is a basic run down on pre payment penalties.

First off, a pre payment penalty is a penalty or fee that a lender will place on your loan if it is paid off by means of a refinance or the sale of the home. There are two terms when talking about pre payment penalties. These terms are "Soft" and "hard" pre payment penalties.

A soft pre payment penalties is where the lenders states that there will be a set fee if the loan is pre payed because the home is sold. When the home is sold there is no pre payment penalty assessed to the borrower (seller at this point). If the loan is simply refinanced, there will be a pre payment penalty assessed.

A Hard pre payment penalty states that if you pay the loan off for ANY reason you will be assessed this fee.

The fees vary from state to state and often these pre payment penalties are controlled by the loan officers that are doing your loan. If we have raised the rate on your loan to get rebate from the lender (extra money that is slid under the table to us loan officers if we jack your rate up) then there is a good chance that a savvy loan officer will throw a pre payment penalty onto the loan...or extend the amount of years on the pre pay. The reason for this is several lenders will require the loan officer to pay this rebate back if the borrower refis within a year or so...its kind of like insurance on the money we earned.

If a program comes standard with a 2 year pre payment penalty (if you refi or sell in 24 months) then there are often options to add another years work of pre payment penalty for even more "under the table" money from the lender.

Most of your conforming loans will NOT have a pre payment penalty. Only your Alt A (right above subprime) and sub prime stuff will have a pre payment penalty.

The actual pre payment penalty can vary. You may have 6 months worth of principal and interest (6 months mortgage payments) that you have to pay. Some times it is a silly ratio such as "interest payments for 5 months on 80% of the principal balance". It will vary from state to state and some states actually do not allow pre payment penalties. Often times when a loan officer is pricing out your loan in one of these states where a pre pay is not allowed, they over look the fact that because there is no pre pay allowed, a lender often will require a higher rate in these states.

Some of these pre payment penalties can be severe! There was a client of mine earlier this year that had an adjustable rate mortgage with a 6% pre payment penalty. She had a loan over 300k so this was 18k in pre payment penalties....a real crime but legal.

You can "buy out" a pre pay often if you either pay a slightly higher rate or pay "points" to buy this out. You would have to look darn close to make sure that it makes sense in the long run and that you have a steady plan and reason for this. It is easy to piss money away by buying out a pre pay.

The pre payment penalty usually will be paid when your old loan is paid off. This is done when the payoff balanced is received. If you have a 100k balance on your loan and a 2% pre pay (lets just say), then when your new lender goes to your current lender and asks for the payoff balance it will be 102k...100k plus the pre payment penalty.

When looking at refinancing, always take into account the true COST of the refinance. Along with your actual CLOSING COSTS, look at any pre payment penalty and add that into the closing costs to figure out how much this is really costing you.

Too many home owners are taking one step forward and two steps back by loosing equity every time they refinance and have to eat a pre payment penalty.

ON the flip side..if you have a strong feeling you will be in your home for a while and you have pretty good deal on the table.......wait til you get a solid good faith estimate from your lender and then ask them how far the rate will go down if you ADD a pre payment penalty onto your loan. Often a lower rate or fewer fees will be the reward for doing this.

So...while it sucks for most, this is a handy little tool and an important part of your loan. Just another thing you have to know before getting a home loan.

Good Luck!