Mortgage Early Payment Penalties
- Early payment penalties apply to certain loans and are disclosed up front.hipoteca americana image by caironbohemio from Fotolia.com
Sometimes mortgages contain a prepayment penalty clause. This clause states that if a mortgage is paid off in full before a certain date, penalties apply. This early payment penalty, if applicable, is disclosed in the closing documents of every loan. Lending institutions demand this penalty for several different reasons, one of which is that to the lending institution, the loan is an investment, and they expect the interest revenue from the loan payments. - Loans with prepayment penalties generally attach a specific number of years to them. A common example is a three-year early payment penalty. This means that if the loan is paid off in full before three years have passed, a penalty is charged. The penalty is documented with the lending institution and typically amounts to the property owner paying a certain percentage of the loan amount or balance as the penalty. If the loan is paid off in full after three years, no penalty exists. This protects the lending institution from losing interest revenue from the property owner.
- Early payment penalties are often referred to as hard or soft penalties. A hard early payment penalty means that regardless of the reason why the loan is paid off during the prepayment penalty phase, prepayment penalties will apply. A soft penalty means that the penalty only applies if the loan is paid off due to a refinance. If the home is sold and the loan is paid off in full, no early payment penalty applies.
- There are several ways prepayment penalties are calculated. One way is if the penalty rate is 3 percent, the owner pays 3 percent of the balance owed at the time of payoff. Another way is a declining percentage. In this case, if an owner pays off the loan within the first year, he pays 3 percent of the loan balance. If the owner pays it off during the second year, the rate drops to 2 percent of the loan balance. If the owner pays it off during the third year, the rate drops to 1 percent. Sometimes another method is used and is based on calculating the amount of interest the lender loses out on if the loan is paid early.
