Prepayment Penalty
A prepayment penalty is a fee charged by some lenders if you pay off your mortgage early—through refinancing, selling, or making large extra payments—within a specified time period, typically 2–5 years. Most conventional and government loans today do not have prepayment penalties, but they can appear on Non-QM and some subprime loans.
Prepayment penalties compensate the lender for lost interest income when a loan is paid off ahead of schedule. A 'hard' prepayment penalty applies if you sell or refinance; a 'soft' prepayment penalty only applies if you refinance (not if you sell). Penalties are typically calculated as a percentage of the remaining loan balance—commonly 2–4%.
On a $400,000 loan with a 3% prepayment penalty in year one, paying off the loan early could cost $12,000. That's a significant deterrent to refinancing if rates drop. Before accepting any loan with a prepayment penalty, calculate whether the better rate or terms justify the potential exit cost.
Under Dodd-Frank, Qualified Mortgages (conventional, FHA, VA, USDA) are largely prohibited from including prepayment penalties. Non-QM loans, hard money loans, and some portfolio loans may still carry them. Always ask specifically: 'Does this loan have a prepayment penalty?' and 'What is the penalty structure?' before closing.
Key Takeaway
A prepayment penalty is a fee charged by some lenders if you pay off your mortgage early—through refinancing, selling, or making large extra payments—within a specified time period, typically 2–5 years. Most conventional and government loans today do not have prepayment penalties, but they can appear on Non-QM and some subprime loans.
Related Terms
Frequently Asked Questions
No. Conventional, FHA, VA, and USDA loans generally do not have prepayment penalties. They can appear on Non-QM, hard money, and some portfolio loans. Always ask your lender before signing.
On most modern loans, yes—without penalty. Making extra principal payments each month reduces your balance faster and can save tens of thousands in interest over the life of the loan.
Check your loan documents—the Note and the Addendum to Note. Look for 'prepayment' language. Your Loan Estimate and Closing Disclosure also disclose prepayment penalties if applicable.
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