Prepayment Penalties

A prepayment penalty can make it costly to sell a home or refinance a mortgage. Before you find yourself in this situation, consider the fact that Loanwise’s offerings do not come with prepayment penalties attached.

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The Purpose of a Prepayment Penalty

Mortgages are profitable for lenders because of the interest that must be paid back on top of the original loan amount. Interest accrues slowly but surely over time, which is why a mortgage with a 30-year term will have a higher overall cost than one with a 15-year term even if the interest rate for each is the same.

The faster a loan is paid off, the less interest accrues. If you get a 30-year mortgage but pay a little extra every month so it only takes 25 years to pay off, your overall cost will be lower.

Example – Loan Amount: $100,000 | Interest Rate: 5% Monthly Payment: $537 | Number of Payments: 360 | Total Cost: $193,256 Monthly Payment: $585 | Number of Payments: 300 | Total Cost: $175,377

Putting a little extra money into your mortgage payment every month makes good financial sense, because it allows you to reduce the amount of interest you must pay.

On the other hand, if you pay off your 30-year mortgage in only 3 years, you will avoid almost all the expected interest, and your lender will lose almost all their expected profit. How often do mortgages get paid off so early? It may be more common than you realize, because when you sell your home or refinance to a new mortgage, you are technically paying off your original mortgage.

Rest assured: Loanwise has no products with prepayment penalties.

Some lenders may include a prepayment penalty in the terms of a mortgage in order to recoup some of the profit they will lose if the mortgage is paid off early. Make sure you ask about this before committing to a lender’s loan offer, and if you are thinking of refinancing, make sure you understand whether and how much a prepayment penalty will cost you.

Smart borrowers avoid prepayment penalties.

Prepayment Penalty Terms

The specific terms for prepayment penalties vary widely in terms of the penalty amount, the effective time period, and what payoff conditions apply:

  • Penalty Amount: You may be charged a certain number of monthly payments, a fixed dollar amount, or a set percentage of the remaining balance.
  • Effective Time Period: The penalty may apply only for the first few years of the mortgage, or it may stay in effect longer, up to the whole life of the loan.
  • Payoff Conditions: A “hard” prepayment penalty applies when the home is sold or the mortgage is refinanced, but a “soft” prepayment penalty applies only to refinancing.
View Sources
  1. Consumer Financial Protection Bureau. (n.d.). What Is a Prepayment Penalty? Retrieved from http://www.consumerfinance.gov/askcfpb/1957/what-is-a-prepayment-penalty.html
  2. Investopedia.com. (n.d.). Prepayment Penalty. Retrieved from http://www.investopedia.com/terms/p/prepaymentpenalty.asp
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