Repaying your mortgage before it comes due seems like a good idea.
Not only do you own your home in a shorter amount of time, you also eliminate a significant part of your debt in a shorter period of time.
While mortgage prepayment works out in your favor, the same isn't the case for the lender. Lenders generally despise mortgage prepayment. When you pay your mortgage in a shorter period of time than expected, the lender receives less in interest than expected. The sooner you pay off your mortgage, the lower the amount of interest the lender received. For this reason, many lenders charge a mortgage prepayment penalty.
The mortgage prepayment penalty is a stipulation in your contract that states you will pay a penalty if you repay your mortgage entirely. The mortgage prepayment penalty can be charged in two ways: as a percentage of the balance of the loan at the time of repayment or based on the number of months remaining in the loan life.
Mortgage prepayment penalties can be charged in the event you sell your home or refinance your loan. If your mortgage contract included a prepayment penalty, it will be considered hard or soft. A hard penalty says that you cannot do either of these transactions without incurring a penalty. You are only subject to a soft mortgage prepayment penalty if you refinance the mortgage.
Penalties can decrease and even be eliminated over time. Usually after five years, the mortgage prepayment penalty is removed altogether. You can make a payment up to 20% of the loan balance in any single year and avoid receiving a mortgage prepayment penalty.
In some cases, prime borrowers, those with good credit ratings or high down payments, or both, are offered the mortgage prepayment penalty option to decrease their interest rate which results in a lower monthly mortgage payment.
If you are extended such an option, it is good to consider the importance of the decrease in mortgage payment to your finances. Other factors that come into play are the length of time the mortgage prepayment penalty remains in effect and whether it is a hard or soft penalty. Hard penalties should be avoided because you can never be sure when you are going have to sell your home.
If you are a sub-prime borrower, with less than favorable credit or a low down payment or both, the lender may require you to have a mortgage prepayment penalty. Lenders realize that if your credit improves you are likely to refinance to obtain a lower interest rate. This, of course, presents a loss for the lender.
So, to prevent this kind of loss, lenders to sub-prime borrowers impose a penalty on borrowers who might refinance in the future. You might not be able to negotiate out of the penalty altogether; however, you can negotiate some of the terms. Insist that the mortgage prepayment penalty only apply for a certain amount of time and that it not apply to a sale of the home.
Before accepting a mortgage prepayment penalty from a lender, make sure the terms of the penalty favor you as much as possible.
