Shopping For A Mortgage
With all this in mind, here are some steps to consider as you shop for a new mortgage:
- Check your credit score and take steps to improve it. Remember that the best mortgage rates go to those with good or great credit. If your credit score is on the lower side, it may be worth taking some time to improve your credit before applying for a mortgage. If your credit isnt that great, you can also consider a government-sponsored home loan program like an FHA loan or USDA loan. Both home loans come free of prepayment penalties and they may be easier to qualify for with poor credit.
- Shop around and compare home loans in terms of their interest rates and fees. Since mortgage lending is competitive and companies must compete for your business, its common for some lenders to offer better mortgage rates and terms.
- Read the fine print. Before you make the final decision on your new mortgage, the Consumer Financial Protection Bureau advises to read through the details of your loan documents. If your mortgage has a prepayment penalty, make sure you understand how much it will cost and how long it lasts.
Check For A Prepayment Penalty
When you apply for a mortgage, the lender must give you a loan estimate within three days. This standardized document includes details about the loan, including the costs involved and whether any loan terms can change.
When you get the loan estimate, look at page 1 under the section Loan Terms / Prepayment Penalty. In the space under the question Does the loan have this feature? the document will say yes or no. If it says yes, then your loan has a prepayment penalty.
The loan estimate will also specify the amount of the penalty and when it may apply.
Thats why its important to compare offers from multiple lenders to find the best terms for a loan.
When Does A Prepayment Chargeopens A Popup Apply
Prepayment charges may apply when you prepay your mortgage balance before the maturity dateOpens a popup. and you:
- Renew, refinance or pay off your mortgage mid-term
- Prepay more than your annual prepayment privilege amount
- Refinance your mortgage and choose a new term
- Transfer your mortgage to another lender
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Mistake #: Not Asking If Theres A Prepayment Penalty
Mortgage lenders are in business to make money and one of the ways they do that is by charging you interest on your loan. When you prepay your mortgage, youre essentially costing the lender money. Thats why some lenders try to make up for lost profits by charging a prepayment penalty.
Prepayment penalties can be equal to a percentage of a mortgage loan amount or the equivalent of a certain number of monthly interest payments. If youre paying off your home loan well in advance, those fees can add up quickly. For example, a 3% prepayment penalty on a $250,000 mortgage would cost you $7,500.
In the process of trying to save money by paying off your mortgage early, you could actually lose money if you have to pay a hefty penalty.
Are There Penalties For Paying A Mortgage Early
According to the Consumer Financial Protection Bureau, lenders sometimes charge a fee for paying off your mortgage early. You may even face a fee if you pay off a significant portion of your loan balance within a short time.
The prepayment penalty depends on your lender agreement. Some mortgage lenders charge a percentage of any remaining loan balance, while other lenders charge the total interest for several months. Still, other lenders charge a flat-rate fee. The purpose of a prepayment penalty is to protect the lender against loss of interest.
If you’re ready to move forward with a mortgage refinance, you can visit Credible to discover the best mortgage refinance rates available today. Plug your information into their free tools to see your new estimated monthly payments with your new loan term.
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Prepayment Penalties: Why They Exist And How To Avoid Them
May 13, 2018 · 6minute read
Were here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey.Read moreWe develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide.We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right.Read less
If you recently got a bonus or just sold off the antique nutcracker collection you inherited from your Uncle Leo, you might consider putting that extra cash toward paying off your loans or getting ahead on your mortgage. After all, one frequently given nugget of financial wisdom is to use unexpected financial windfalls to pay down your debt. But what happens when paying down your loans comes with a prepayment penalty?
Loan prepayment penalties are fees lenders might include in their terms to ensure you pay a certain amount of interest on your loan before paying it off. It might sound crazy, but making extra payments or paying your loan off early can actually cost you more because of loan prepayment penalties.
Mistake #: Extending Your Loan Term When Refinancing
Refinancing can save you money in multiple ways, as it allows you to convert to either a shorter or longer loan term, depending on whats best for you. So if youre 10 years into a 30-year mortgage term, you could potentially refinance to a 10-year term and shave off 10 years. On the flip side, you could go for another 30-year term to lower your monthly payments.
However, loans with shorter terms tend to have lower interest rates, allowing you to both save on interest and reach full ownership much sooner. In some cases, though, refinancing could cost you more in the long run, especially if youre planning to extend your loan term. Before you refinance, its a good idea to crunch some numbers and figure out whether having a longer mortgage term really makes sense.
Dont forget closing costs either. If your lender agrees to let you roll those costs into your loan, you could end up paying more money. After all, youll now be on the hook for interest on a larger loan amount.
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The Bottom Line On Mortgage Prepayment Penalties
Thankfully, mortgage prepayment penalties are fairly rare these days. You can avoid one by taking out a conforming loan, or an FHA, VA, or USDA loan .
If you’re getting a non-conforming mortgage, your loan may be subject to an early mortgage payment penalty. Read your loan documentation carefully. Your lender is required to provide you with a detailed summary of your loan terms. As a result, your mortgage should state explicitly whether it comes with a prepayment penalty or not.
Shop around with different lenders, since you may find that not all of them charge a pre-payment penalty. And if you’re a strong loan candidate — meaning, you have a good , little debt, and a healthy income — you may be able to negotiate a prepayment penalty out of your loan contract.
Are Prepayment Penalties Always Legal
If you think prepayment penalties sound like trouble, youre not alone. In fact, the Consumer Financial Protection Bureau deemed them a risky loan feature. In 2014, the agency implemented rules to restrict how much lenders can charge in prepayment penalties on certain mortgages.
Some states go so far as to ban prepayment penalties on all types of loans. But some banks are regulated by federal law, not state law, so its key to do your research and talk to your lender so you know which policies apply to your loan.
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Prepayment Penalties & Permanent Rental Investors
The rental investors looking to grow a legacy of rental properties and hold on to them long-term are not really affected by the prepayment penalty. Since their investment strategy focuses on the lifetime of the loan, paying off the loan early is a moot point.
At Visio, our permanent rental borrowers stick with our standard 5/4/3/2/1 prepayment penalty structure and often pair it with our 30-year fixed rate structure. These borrowers will often also pay higher origination fees in order to lower their monthly payments. Over the span of the loan, these borrowers will ultimately save money.
Personal Loan Prepayment Penalties
For example, if you take out a $6,000 personal loan to turn your guest room into a pet portrait studio and agree to pay your lender back $150 per month for five years, the term of that loan is five years. Although your loan term says it cant take you more than five years to pay it off, some lenders also require that you dont pay it off in less than five years.
The lender makes money off the monthly interest you pay on your loan, and if you pay off your loan early, the lender doesnt make as much money. Loan prepayment penalties allow the lender to recoup the money they lose when you pay your loan off early.
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How To Avoid A Mortgage Prepayment Penalty
What borrowers need to know to avoid extra costs.
If youre thinking about taking advantage of a lower interest rate, a mortgage refinance may be in your future. But before you make the switch, you may want to know how to avoid a mortgage prepayment penalty a hefty fee some lenders charge for repaying your loan too early. Here’s everything you need to know about the penalty fee before making any financial decisions.
Mistake #: Not Considering All Of Your Options
It can be very tempting if you come into some extra money to put that toward paying your mortgage off ahead of time. However, getting out of debt a little bit earlier may not be the most remunerative choice to make. To illustrate this, lets look at an example.
Lets say youre considering making a one-time payment of $20,000 toward your mortgage principal. Your original loan amount was $200,000, youre 20 years into a 30-year term, and your interest rate is 4%. Paying down $20,000 of the principal in one go could save you roughly $8,300 in interest and allow you to pay it off completely 2.5 years sooner.
That sounds great, but consider an alternative. If you invested that money in an index fund that represents the S& P 500, which averages a rate of return on 9.8%, you could earn $30,900 in interest over those same 10 years. Even a more conservative projection of your rate of return, say 4%, would net you $12,500 in interest.
Everyones financial situation is unique, and its very possible that the notion of being out of debt is so important to you that its worth a less than optimal use of your money. The important thing is to consider all of your options before concluding that paying off your mortgage earlier is the best path for you.
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Types Of Mortgages Without Prepayment Penalties
Most government-backed mortgage loans do not impose prepayment penalties. These programs are known to help consumers afford houses with low or zero down payment options. These mortgages include Federal Housing Administration loans , U.S. Department of Agriculture loans, and U.S. Department of Veterans Affairs loans. Apart from mortgages, even student loans do not impose early payment penalties.
Meanwhile, conventional mortgages and jumbo loans may have prepayment penalties. You must talk to your lender to clarify if your loan comes with this arrangement. Take note: Certain conventional mortgages such as fixed-rate loans and other qualifying mortgages must abide by the amended Regulation Z of 2014. In some instances, if an adjustable-rate conventional loan qualifies under QM, it should not have a prepayment penalty.
Can A Prepayment Penalty Be Avoided
Yes — but only before you sign your mortgage. If you have an existing mortgage with a prepayment penalty, there’s nothing you can do.
These days, the majority of mortgages do not have prepayment penalties. Conforming loans, as well as FHA, VA, and USDA loans, cannot include that penalty. So if you borrow via one of these channels, you should be able to completely avoid the prepayment penalty.
On the other hand, if you take out a jumbo mortgage , your home loan may be subject to a prepayment penalty. This means that if you sell your home soon after closing, or you try refinancing your mortgage, you might get stuck with a prepayment penalty.
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Can I Borrow 5 Times My Salary
Yes. While its true that most mortgage lenders cap the amount you can borrow based on 4.5 times your income, there are a smaller number of mortgage providers out there who are willing to stretch to five times your salary. These lenders arent always easy to find, so its recommended that you use a mortgage broker.
Calculating The Prepayment Penalty
Even though the banks have to host their own prepayment calculators, the legal jargon used on many can still leave even the most educated homeowners confused. Because of this, we decided to take on the responsibility of researching and explaining each banks calculations in the simplest terms possible, so no one is left in the dark about how these penalties work. The first bank we are going to look at is CIBC.
Depending on if you have a fixed or variable rate mortgage, CIBC will charge you one of two fees:
- Three months interest, or the
- Interest rate differential .
If you have a fixed rate mortgage, you will pay the greater of three months interest or the interest rate differential. If you have a variable rate mortgage, however, you will always pay just three months interest. Lets review how both calculations work.
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How Much Will It Cost To Break My Mortgage
This depends as there are many costs associated with breaking a mortgage. The most significant cost you will incure is from theprepayment penalty. Depending on your lender, the prepayment penalty may differ. We highly recommend going over your current mortgage contract or talking with an experienced mortgage broker to get advice before making any decisions.
The prepayment penalty will differ from lender to lender. But generally, there are two methods in calculating the penalty:
Method 1: 3-months of Interest
For breaking a variable rate mortgage contract, the penalty is usually 3-months of interest applied to the remaining principal of your mortgage at your currently set interest rate. This method also applies to a fixed rate mortgage, if the the 3-months of interest total is greater than the total gotten from the calculation described in method 2 below.
Method 2: Interest Rate Differential
You have a 5-year fixed rate mortgage with a current interest rate of 3.25%. Of those 5 years you have 3 years left on your agreement with a current principal value of $400,000. You decided to break your mortgage contract and so this is how the IRD is calculated.
Example Of An Ird Calculation
Lets say you have a $200,000 mortgage balance with a 5-year term and a posted interest rate of 4.5%. If, after two years, you decide to transfer the mortgage to another institution, your lender has suddenly lost the interest they were counting on over the next three years to cover their expenses and make a profit.
They can turn around and re-lend the money to someone else, and they will, but what happens if the interest rate has dropped, and they can only lend at a rate of 3.0%. The bank needs to recoup the difference. To illustrate heres a straightforward IRD calculation:
In this case, a 3-month interest charge would only be $2,250, so the IRD of $9,000 would apply because its the higher of the two.
- 3-month Interest Charge: $200,000 X 4.5%/12 = $750 X 3 months = $2,250
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Prepayment Penalty: What It Is And How To Avoid It
The phrase prepayment penalty is likely making you curious. After all, why would you be penalized for prepaying something, which almost always is a benefit to the entity being paid? Well, thats the thing about mortgage loans: Many of them surprisingly come with prepayment penalties, which limits your flexibility and can take a bite out of your wallet just for trying to do the right thing for your finances.
So when youre looking at home loans and trying to decide what is the best type of mortgage for you, this is a feature you should be aware of, as prepayment penalties are sometimes hidden in mortgage contracts. By learning about penalties now, you can approach your mortgage search and eventual contract with more knowledge, armed with strategies for finding the best mortgage lender to fit your needs. Its important to note that Rocket Mortgage® does not have any prepayment penalties.
Is There A Mortgage Payment Calculator For Mcap
Use this Mortgage Payment Calculator to find some of the customizable solutions available for your mortgage to help you become mortgage free sooner! Your MCAP mortgage may allow you to make changes to your payment amount or frequency. Have you ever wondered how increasing your payments might help pay off your mortgage sooner?
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