There are two types of prepayment penalties: "soft" prepayment penalties where you are only charged if you refinance your loan and "hard" prepayment penalties where you will be charged a fee if you refinance or sell your home.
Prepayment Penalties Are Common With Subprime Mortgage Loans In most subprime loans, prepayment penalties are more the rule than the exception.
Most subpime loans that are in the form of a 2/28 ARM have a standard two year hard prepayment penalty and 3/27, 5/25 ARMS and 30 year fixed loans typically carry a three year prepay.
When you are quoted a rate from a subprime lender, you can pretty much assume that the rate quoted is with a prepay penalty unless you are told otherwise.
How Mortgage Companies Make Their Money Imagine a friend lent you $1,000 and gave you a year to pay it off, but you came into some money after three months and paid him back in full.
Your friend would be thrilled, right?That is not the case with most lenders.
The first few years ofyour mortgage payment go mostly to interest, not the principal loan balance.
Thus, the early years of your mortgage is when lenders make most of their money.
How Much Will a Prepayment Penalty Cost You? So how much would a prepayment penalty cost you? On a three year prepay, the lender will charge you 3% of the loan amount if you paythe loan off during the first year, 2% during the second year and 1% during the third year.
Suppose you take out a $200,000 loan with a three year prepay and decide to sell the property after 9 months.
The lender will probably charge your $6,000!If you promise to stick with the same lender, they my forgive that charge.
Prepayment Penalties Are Optional The good news is that prepayment penalties are almost always optional.
In exchange for a higher rate, your lender can reduce or even eliminate your prepayment penalty.
If you're uncertain that you will staying in your home for more than three years, getting rid of that prepay could potentially save you thousands!