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What You Should Know About Prepayment Penalties

a black dog looking confused inside a home

Buying a home usually requires financing in the form of a mortgage, and mortgages usually come in 30- or 15-year terms. Many homeowners plan to pay off their mortgage early and reap the benefits that come with owning a home outright sooner and saving hundreds or even thousands on mortgage interest. However, some mortgage contracts include prepayment penalties that might make it difficult to pay off a mortgage early. Read on to learn the basics about prepayment penalties and how you can avoid them.

What is a Prepayment Penalty?
A prepayment penalty, simply enough, is a fee assigned if you pay off your mortgage or pay it down too quickly. This fee applies to not only paying your mortgage down or off in a certain amount of time, but also the sale or the refinancing of a home. These penalties protect and reimburse your mortgage lender for the loss of the interest income that they would have received if you had not paid off your loan so aggressively.

How Much is a Prepayment Penalty?
A prepayment penalty is assigned by your lender and is a part of your mortgage contract, so understanding what your penalty might be is as easy as speaking with your lender or looking through your mortgage contract. After all, mortgage lenders are legally required to let you know when a prepayment penalty is written into your contract in the “prepayment disclosure document.” The cost of these penalties can vary, but may be set as a lump sum or as a percentage of the principal balance remaining on your mortgage loan at the time the penalty is assessed.

Does Every Mortgage Have a Prepayment Penalty?
While prepayment penalties were once a common occurrence, especially as a clause in sub-prime mortgage loans, they have largely fallen out of favor with mortgage lenders nationwide as the housing market continues to improve. Before you buy a home, you should ask your lender specifically about prepayment penalties, especially if you plan to pay off your home at a faster or accelerated rate than is stipulated in your mortgage contract.

Are These Penalties Ever a Good Thing?
Although prepayment penalties might sound like a bad thing, in certain situations, having them in a mortgage contract can be a positive thing for some borrowers. Sometimes, accepting a prepayment penalty written into your contract can allow the mortgage lender to give you a more favorable mortgage rate, which can decrease the amount of interest that you pay over the life of your loan. In addition, sometimes accepting a prepayment penalty can help borrowers who lenders see as higher risk get a loan in the first place.

Understanding prepayment penalties is an important step in starting to understand the mortgage process. The NC Housing Finance Agency has resources to help you learn more about becoming a homeowner and affordable mortgage products to help get you there. Learn more about all the ways the NC Housing Finance Agency can help make home ownership happen for you at www.nchfa.com/home-buyers.