Mortgage lenders would rather have order than chaos. Some lenders take this idea to its logical end by adding prepayment penalty clauses to mortgages.
How to Understand the Penalties for Paying Off a Home Loan Early
When a mortgage lender looks at an application for a loan, they do a number of things to figure out what the risk and profit scenarios are. Many lenders look at how likely it is that you will pay back the loan within a certain amount of time. To make sure this happens, they put penalties in the loan documents for paying off the loan early. You can still refinance, but the fees make it a risky financial move most of the time.
Prepayment penalties are just rules that say you have to pay a fee if you pay off your mortgage before a certain date. The punishments can be like points, a certain number of payments, or a set fee. States, not the federal government, make the laws about penalties, so there are many different kinds. Since states rarely pass the same law, each has its own rules about what lenders can and cannot do. To find out where you stand, you will need to look at the laws in your state or talk to a mortgage broker.
The fees for paying off a loan early can be huge. No matter what formula is used to figure them out, you can expect to get the maximum penalty allowed by the laws in your state. The lender wants you to keep doing what you agreed to do with the first loan. If you try to refinance, they will want a piece of what you are selling. This is true even if you have to sell the house because of an emergency, a divorce, losing your job, or something else bad that can happen in life.
If you can, you should try to stay away from mortgages that have prepayment penalties. They are just not worth the trouble. If you have to take a loan with a penalty clause, try to find one with the shortest penalty time. Some lenders will want the prepayment penalty to last for the whole loan, while others may only want it to last for a year or two. It is highly recommended that you don't take out a loan that has a penalty for paying it off early at any time during the life of the loan. In the long run, you will be sorry you agreed to such a loan.
Home loans are a competitive business, which is a good thing. Most mortgage lenders have done away with prepayment penalty clauses or at least made them less harsh so they can compete for your business. Still, do everything you can to stay away from these brutes.
