Banks are always trying to get as much money out of you as possible when closing any sort of Mortgage loan. One type of penalty/fee that can be worked in is a mortgage prepayment penalty. It’s a good idea to try to avoid paying these fees as much as possible, especially a penalty like this that actually penalizes you for doing a good thing.
What Is Prepayment?
Sometimes, mortgage lenders give their clients the choice of making their mortgage payments before they are actually due. They call this prepayment and it applies when people pay a portion of the loan early or they could be paying the entire amount. People like to do this because over the length of a loan, the lender is charging a lot of interest.
For example, suppose it is a 30-year loan. The lender would have looked at the borrowers’ financial situation, how much they owe in debt, how much they earn, what their credit scores are and their work history. If after they have thoroughly examined these people’s finances they discover that these people have a risk of defaulting on the loan, they offer these people a higher interest rate.
If the interest rate is a fixed rate, then it will remain at that amount throughout the entire term. If the interest rate is at six percent, these people will be paying this amount in interest every month. It can also be an adjustable rate. The borrowers, in these cases, are given a low introductory interest rate that, generally, lasts for five years. After this period is over, their rates will be adjusted to a higher rate.
Ways to Prepay a Mortgage Loan
People can prepay their mortgages in two different ways. In the beginning of a mortgage loan, most of the monthly payment goes toward interest. People can choose to designate more money toward the principle by paying above the amount that is due. They can do this every month if their lenders allow it.
The other way to prepay a mortgage is to refinance. Refinancing would mean that people are obtaining a loan that will completely pay the first mortgage in full. People like to refinance so that they can obtain a lower interest rate that lowers the amount they pay each month and it also helps them pay these loans off at a faster rate.
Why People Think of Prepaying Their Mortgages
Whether it is a fixed rate or an adjusted rate, people are paying a lot of money in interest over the life of their loans. If they discover that they have a little extra money, they may decide that they would like to put it toward paying down their mortgage principle. The lenders aren’t always in favor of this idea. They like people to have long terms, like 30 years, where they will be paying interest for a long time on their mortgage loans. It reduces the money they will make if their clients are prepaying their mortgages and to discourage this practice, they will charge a prepayment penalty.
The Prepayment Penalty
When lenders write mortgage contracts, they guard against the risk of prepayment by writing into the contract that there will be a prepayment penalty if the borrower decides to pay the loan early. Some lenders charge a percentage on the remaining principle as the penalty for paying early. Other lenders will charge several interest payments that the borrower would have paid if the loan were left in place.
Adjustable rate mortgages are typical loans that will have prepayment penalties a lot of the time. People have a huge incentive to refinance these types of mortgages after they have adjusted to a much higher rate and to ensure this doesn’t happen too often, lenders write prepayment penalties into their contracts.
They may also discourage people from selling their houses, which would cause them to pay their mortgages in full earlier. Generally, the contract will state that a prepayment penalty will apply if the house is sold before five years have passed. This way, they can keep people from wanting to sell their houses too quickly.
Ways to Avoid the Prepayment Penalty
1. Accept a Higher Interest Rate. When people are accepting an adjustable rate mortgage or they are being offered a very low interest rate, they have reason to suspect that the lenders will write a prepayment penalty into the contract. Make sure to ask this question before accepting the interest rate. If the prepayment penalty is motivating them to offer the lower rate, offer to pay a higher rate to have the prepayment penalty left out of the contract.
2. Shop Around. People don’t have to accept the terms that lenders are offering them. They can go to another lender who will be willing to give them a loan without a prepayment penalty.
3. Hire a Real Estate Attorney. Attorneys will be able to give their clients the best advice on how to prevent a prepayment penalty from being written into a contract based on their personal situations.
4. Ask for a Waiver. Lenders aren’t usually insistent on a prepayment penalty for selling the house, but they aren’t necessarily going to tell their clients about it. People must make sure to ask them to remove this clause from the contract and they will, most likely, do so.
5. Ask to Have the Prepayment Penalty Removed. If the loan’s contract has already been written, it’s not too late to avoid the prepayment penalty. Good paying customers are in the best position to be able to have their prepayment penalties removed from their contracts. All they have to do is ask.
