Purchasing a home comes with a bittersweet mix of excitement and overwhelm. Although the sheer size of your mortgage loan makes you think paying it off is nothing more than a pipe dream, you begin to see that early repayment may mean sizable cost savings. But paying off your mortgage loan early can potentially expose you to specific penalties.
This post defines mortgage prepayment penalties and the costs and effects you may face should you consider paying off your mortgage loan early. Keep reading to find out the answers to the following common questions:
Having a large mortgage loan looming over your head (and bank account) can be overwhelming. It’s common among homeowners to want to pay off their mortgage as soon as possible and own their home outright. But before you pay off your remaining mortgage balance, you must think through the financial ramifications of paying debt off early.
Here are some questions to consider to know if it makes sense to pay off your mortgage early:
These sometimes called prepay penalties, are fees some mortgage lenders charge you when you pay off all or part of your mortgage loan before schedule. At their core, mortgage prepayment penalties have incentives for both borrowers and lenders. With traditional 15-year or 30-year mortgages, you as the borrower have a lower overall principal payment. On the other hand, your mortgage lender gets to collect interest over that same period of time.
Paying off your mortgage early means your mortgage lender will not recoup the costs of lending you the money, leaving them in a riskier financial situation.
Because mortgage lenders are taking a financial risk in lending you a large mortgage loan, the payments you make on your mortgage loan serve to protect the mortgage lender from any financial hardships if you fail to pay off the loan. The mortgage prepayment penalty sets a foundation for lower interest rates for you while protecting the lender with lower financial risk.
Prepayment penalties do not incur on principal-only payments or yearly payments of less than 20% of the loan balance. However, once you cross that threshold or refinance your loan, prepayment penalties will likely be applied.
Mortgage prepayment penalties vary by lender. Depending on a variety of factors, such as loan type, length of the loan, and how much of an advanced payment you’re making, your mortgage prepayment penalty can quickly add up.
Having said this, mortgage prepayment penalties are most often calculated as a percentage of your mortgage loan total or can be equal to a certain set of monthly interest payments.
These are the most common calculations for determining a mortgage prepayment penalty fee:
While some of these methods are more common than others, you should reach out to your mortgage lender to ensure you know how they process mortgage prepayment penalties and what the trigger is for such penalties.
One of the best ways to avoid mortgage prepayment penalties is to work with a trusted home loan advocate like us to ensure you find the best lender for your unique situation before you purchase a home.
Because many mortgage lenders write a prepayment penalty clause right into your mortgage contract, it’s important that you carefully consider all addendums and disclosure documents you sign at closing. While prepayment was not on your mind when you closed on your new home loan, the truth is your lender knows prepayment on a mortgage loan comes with financial risk.
Another option is to stay away from certain types of mortgage loans that include prepayment penalties as common contract provisions. Loans like conventional loans, Small Business Administration loans, subprime mortgages, and other alternative loan types. While it may seem that all mortgage loans include prepayment penalties, there are still options on the table. For example, USDA and FHA loans prohibit prepayment penalties.
For a detailed list of mortgage loans available to buyers, check out our blog post given: here If you have questions about how mortgage prepayment penalties could affect your home-buying purchase or how to select a home mortgage lender that’s right for you. Contact us today