Many people make a major mistake when applying for a mortgage. They are so relieved to get the loan that they fail to pay attention to prepayment penalties in the loan documents.
With the refinance craze of the last few years, many borrowers have been surprised to find they are locked into their loan with prepayment penalties. Boiled down, these penalties require borrowers to pay fees if they pay off the loan prior to a certain point in time. By including such language in the loan documents, some lenders are trying to ensure they will recover a certain amount in interest on a loan as well as reach a certain maturity date on the loan. Lucky you.
Prepayment penalties come in a variety of forms. First and foremost, state law controls the amount and types of penalties that can be charged by a lender. Of course, this means each state has different laws and you should make sure you understand what can be done in yours.
As to the payments themselves, they typically come in two forms. The first is a percentage of the overall loan For instance, assume you have a $400,000 mortgage and the prepayment penalty is 3 percent. Your prepayment penalty will be $12,000. This is typically true even if you are selling your home because of financial difficulties.
In some states, prepayment penalties can come in the amount of interest to be charged over a period. Assume you are paying $2,000 a month in interest on your loan. The prepayment penalty may be something equal to 10 months of interest from the date of prepayment. Put another way, you are looking at a $20,000 prepayment penalty. Obviously, such a payment is going to be a dent in any profit you would pull from the home.
Lenders are not required to identify prepayment penalty language in loan documents. You absolutely must read your loan documents to make sure penalties aren�t included.
Prepayment penalties are not mandatory in loan documents. If a lender refuses to waive the penalties, make sure to shop around for a better deal. Don�t get pounded on the back end of the loan.