A mortgage lender in the Lone Star State relies on years of interest payments to turn a profit. If a borrower decides to pay off the conventional loan or the VA loan in Lake Dallas, Corinth, and Denton according to schedule, its owner will make a ton of money in the process.
However, average American homeowners are less likely to hold on to their mortgages until the end of the term. To protect the financial interests of lenders without imposing a mortgage prepayment restriction outright, a hefty penalty can be applied to make up for the interest will no longer be collected.
A prepayment penalty, a prepay for short, is more prevalent during the housing boom in the 2000s. Nevertheless, it can still make its way into your mortgage contract. Its concept can be self-explanatory, but it is not exactly straightforward.
To help you understand how it works, let us debunk the most common misconceptions about it.
A Prepayment Penalty Can Be on Any Loan
No, it can’t be applied to any home loan program. As a general rule, government-backed mortgages, such as FHA, VA, and USDA loans, do not have prepayment penalties.
If you take out any of these, you should not be worried about getting hit with any monetary punishment for paying off your loan early. Prepayment can come with a caveat, but the extra cost will be nowhere near the size of an actual penalty.
A Prepayment Penalty Lasts Forever
If you take out a loan where a prepay is applicable, it is only enforceable over a short period. The law says that this fee can be charged during the first three years after the mortgage is consummated, the date when you become contractually obligated to take care of it.
This three-year rule applies only to loans taken out after January 10, 2014. It does not have a retroactive effect, so the previous regulations government prepays are observed when a loan was made before the said date.
A Prepayment Penalty Can Go as High as a Lender Wants
The law limits the amount of prepay a lender can charge. During the first two years when the mortgage was consummated, its lender can’t charge a penalty higher than 2% of the outstanding principal. By year three, the limitation goes down to 1%.
Typically, a mortgage charges a penalty equivalent to 80% of six months of interest-only payments. The size of this fee depends on when you pay off your loan and its balance at the time of prepayment.
A Prepayment Penalty Kicks in Immediately After an Overpayment
You do not have to pay off your mortgage early to be held liable for a prepay. A substantial overpayment might suffice for it to come into effect. Most lenders, however, allow a borrower to pay up to 20% of the mortgage balance every year. If you do not go above the threshold your lender set, you can overpay penalty-free.
No matter how long you intend to keep your mortgage or how much you are willing to overpay, thinking about the prepay before you make a move matters. Otherwise, you might not enjoy the full benefits of prepayment and pay thousands of dollars for one careless mistake.