Prepayment Penalty
Definition and meaning of Prepayment Penalty in real estate.
A prepayment penalty is a fee charged by a lender when a borrower pays off all or a significant portion of their mortgage balance ahead of schedule.
In more detail
Lenders charge this penalty to recoup some of the interest income they lose when a loan is paid off early, which often happens when a homeowner refinances or sells the home. These penalties are typically structured as a percentage of the remaining loan balance or as a set number of months of interest.
Federal laws prohibit these penalties on standard government-backed loans, and many states have banned or restricted them on conventional home loans. When they do exist, prepayment penalties usually only apply during the first three to five years of the loan term.
Key facts
| Category | Mortgages & Financing |
|---|---|
| Typical duration | First three to five years of the loan |
| Watch out for | Refinancing or selling a home early when this fee is active |
| Applies to | Some conventional mortgages and commercial loans |
A homeowner refinances their mortgage during the first few years of their loan term and pays a penalty equal to six months of interest, as specified in their contract.
Frequently asked questions
How can I avoid a prepayment penalty?
You can avoid it by choosing a loan that does not include this penalty, or by waiting until the penalty period expires before refinancing or selling your home.
Are prepayment penalties allowed on FHA loans?
No, federal regulations prohibit prepayment penalties on all FHA, VA, and USDA home loans.
Related terms
Sources & references
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