A prepayment penalty is a fee charged to the borrower should the loan be paid off early.

Mortgage loans with lower-than-market interest rates are sometimes offered to borrowers to help offset the initial costs of home ownership. The prepayment penalty then ensures that the loan will not be refinanced before the lender can recoup lost upfront revenue.

The amount of a prepayment penalty varies with the lender and the loan program but can range anywhere from 1 percent of any extra payments, or more commonly, 2 percent of the remaining loan balance. Prepayment penalties are NOT part of the interest rate. Usually up to 20 percent of the loan balance in any given year may be paid off without penalty and most prepayment penalties expire in three years from the start of the loan.

Generally, prepayment penalties have proven so unpopular with consumers many lenders are dispensing with them. In addition, not all loans have prepayment penalties and many states strictly limit or outlaw them altogether. Prepayment penalties are not allowed on FHA and VA loans.

However, do not be too quick to turn down a loan just because it has a prepayment penalty. If you are able to secure a great interest rate, plan to stay in your home for more than three years and do not plan to refinance before the prepayment penalty expires, the penalty will probably not be an issue for you.

Check with our Loan Specialist when you make your application to see if a pre-payment penalty loan program can be beneficial to you.