Prepayment penalties can be expensive

Read the fine print; it could include a prepayment penalty

The market for mortgage refinancing has been quite active during the last five years, as interest rates have fallen to their lowest levels in decades. Even now, as interest rates have risen to some 6.5%, the rates are quite favorable when compared to those of the early 1990’s. As a result of these relatively low rates, millions of people have refinanced their mortgages at lower rates in order to reduce their monthly house payment. It’s great for the homeowner and great for the lenders, who receive thousands of dollars in fees every time a property is refinanced.

But not everyone makes out on a refinancing deal. The loser is the lender who had the old mortgage. When you refinance, the old mortgage is paid off and a new one created, often with a different lender. When that happens, the steady income that the old lender had in interest suddenly goes away.

In order to steady this source of income, many lenders have added prepayment penalties to their loan documents. A prepayment penalty is a fee that the homeowner must pay should he or she pay off a loan before a date that is specified in the document.  That date can range from day one of the loan up to fifteen years from the date the loan is issued, depending on the lender and the wording. This would include either an actual payoff or a payoff through a loan refinancing. Some loans even have penalties for a “substantial” payment; this often means that any payment of at least 20% of the loan principal would trigger the penalty clause. These clauses can be found with all types of mortgages, including fixed-rate and adjustable rate loans.

These fees, which often amount to thousands of dollars, are often waived by the lender if you sell the house. There is no reason to penalize a homeowner for selling a home outright, but lenders may penalize you for seeking out another loan. 

So what can you do about a prepayment penalty? The first thing the savvy consumer would want to do is find out if such a penalty exists before he or she agreed to take the loan in the first place. While some lenders will require a prepayment penalty in exchange for a slight reduction in the interest rate, other lenders will insert the clause simply as a possible source of additional income later. Before agreeing to loan terms, you should ask your lender if your contract includes a prepayment penalty. If it does, you can ask to have it removed, or you can possibly negotiate to keep it in the contract in exchange for a concession if the lender hasn’t offered one already.

Remember, you are in control of the contract, as the lender cannot force you to sign it. If there is a prepayment clause in the contract and you are unwilling to agree to one, let the lender know. Only you are responsible for the documents you sign, so don’t agree to any terms with which you disagree. Failure to heed this could mean having to pay thousands of dollars in otherwise unnecessary fees later if you decide to refinance your mortgage. And paying unnecessary fees isn’t too smart, is it?