The Truth About Prepayment Penalties
Most consumers are scared silly by the thought of a prepayment penalty on their mortgage. Stories abound of homeowners going to sell or refinance their homes only to find out that their mortgage broker snuck in a prepayment penalty on them without telling them. Or, a home buyer gets to the closing table only to discover that their mortgage has a prepayment penalty attached to it that they were not told about. By then, it’s too late. You want the house, so you sign anyway.
Why does this happen? What is the deal with prepayment penalties anyway?
Prepayment penalties are not common in today's banking world. Some loan programs automatically have prepayment penalties, but in most cases, a prepayment penalty is an option and you should have a choice in the matter. So why would you want to accept a prepayment penalty? Simply put, accepting a prepayment penalty should result in a lower interest rate.
That being said, there are many shady characters in the mortgage business. Many of them will sneak a prepayment penalty into your loan without telling you and will give you the same interest rate as you would be able to get without the prepayment penalty. They do this because it results in a larger commission for them.
An honest mortgage broker will give you the choice and help you weight the options of prepay vs. no prepay.
There are two types of prepayment penalties: Hard and soft prepays.
Hard Prepayment Penalties: These are the traditional prepayment penalties that most consumers are familiar with. A hard prepay is one in which you are penalized if you refinance or sell your home within a certain time frame. Typically, the penalty is 6 months interest, but the amount of the penalty varies from lender to lender. Most prepayment penalties have a time frame of 1-3 years.
Soft Prepayment Penalties: As you can probably guess from the term “soft,” this kind of prepayment penalty is not as bad as a hard prepayment penalty. If you have a soft prepayment penalty, you are only penalized if you refinance, and are not penalized if you sell the home. This is a great option in a rising interest rate environment like we are seeing today, as it is unlikely you will have to refinance.
Hopefully, now you have a better understanding of prepayment penalties and the advantages and disadvantages of them.
If you would like to work with an honest mortgage broker who will help you take a look at the benefits of different mortgage programs, give RJ Baxter a call for a free consultation.