Hard Prepayment Penalty - Hard prepayment penalty applies to the loan throughout the specified term of the loan. If you refinance, sell the home or even make additional principal payments, you will most likely trigger a prepayment penalty.
The terms of your prepayment penalty can be found in the Mortgage Note that you signed at closing. There should be a specific section that explains how long the prepayment term is, what the penalty amount is, and what is considered prepayment. Often times other than paying the loan off in full, if you pay down the balance more than 20% in any 12 month period it will be considered prepayment and you will be assessed a penalty.
As long as you plan to live in your home through the prepayment period you have nothing to worry about. If you plan on leaving before that time ask your mortgage broker if the lender will waive the pre pay in exchange for a higher interest rate.
If you have a hard prepayment penalty on your loan and you are considering refinancing your home, consult your current mortgage lender to find out if they will waive the prepayment penalty for you if you decide to refinance with them. You can also try contacting your personal mortgage professional who arranged your current loan for you to see if there is anything that they can do. If the lender or mortgage professional are unable to do anything to get the prepayment penalty waived then you should look long and hard at the numbers and decide if having to pay the prepayment penalty is worth it to still refinance. Beware of prepayment penalties that are 6 months or 12 months worth of mortgage interest. These prepayment penalties can be outrageously high and should be avoided at almost all costs.
Make sure you compare interest rates with and without a prepayment penalty. Typically accepting a prepayment penalty will give you a lower interest rate. As long as you are not planning on moving within the term of the prepayment penalty, it may be beneficial to you.
Prepayment penalties are particularly bad if you are getting a loan with one but don't know about it. Otherwise, decide if you should have a prepayment penalty or not based on how long you know you will be keeping the loan.
Always ask if the loan you are applying for has a prepayment penalty. Also, ask if a prepayment penalty option is available and what the monthly savings would be if you took a 12 or 24 month prepay penalty with your loan. If you plan on keeping the mortgage, the savings may be worth the risk of an unplanned move.
In contrast to a hard prepayment penalty, which is enforced if you refinance your mortgage or sell your home, a soft prepayment penalty is one that only is enforced if you refinance your home.
Prepayment Penalties are generally considered to be prepaid interest, and are in many cases wholly tax deductible as a result. Please consult your tax professional for more information about how prepayment penalties and mortgage interest may affect your personal tax situation.
Prepayment Penalty Options - You may be offered a lower rate if you choose to take a pre-payment on your mortgage loan. Companies will have a couple options as far as the pre-payment penalty in which you can choose from. The most common being a hard pre-payment penalty which will require you to pay a certain amount of money if you pay your mortgage off in a set period of time. A soft pre-payment penalty usually allows you to sell your loan during the pre-payment term and not have to pay a penalty.
There are many different pre-payment penalty set-ups in regards to them being hard and soft, with some being a combination of the two.
Since loans that have a 3 year prepayment penalty often pay the mortgage broker the maximum commission, if you still want a pay option type loan, and you want to avoid the prepayment penalty, many times a honest broker would be willing to credit you a portion of the commissions to save towards the prepayment penalty in the event that you sell or refinance your home before the 3 yrs. For example, if the broker can give you X loan and make 2%, OR he could offer you a pay option which gives you the flexibility to make the payment you want (with a prepay penalty however) and it pays the broker 4%, perhaps they would be willing to credit you the 2%, still make the same amount of $ that they would have on your alternative option, yet give YOU the power to decide what your monthly payments will be.
The charge is generally expressed as a percent of the loan balance at the time of prepayment, or it can be a specified number of months interest. It is not allowed for FHA or VA loans.
For borrowers in Adjustable Rate Mortgages whose fixed periods are coming to an end, it may be advisable to consider the option of refinancing that ARM mortgage into a secure fixed rate mortgage, even if you have a prepayment penalty. Provided that you have adequate equity in the property to absorb the initial cost of paying of the loan with the prepayment penalty, the majority of prepayment penalties are prepaid mortgage interest and are thereby tax deductible for qualified individuals, so you will receive a deduction for the amount when you file your taxes, which for many can be as valuable as the interest itself. Of course we do not dispense tax advice, so you should consult your CPA or tax preparer for more information on how mortgage interest deductions apply to your personal tax situation, however once you've done that we invite your calls at 415-617-5448 or emails at [email protected]
If you plan on moving or refinancing before the prepayment penalty expires, it's a good idea to avoid getting one. The advantage to a prepayment penalty is that you will recieve a lower interest rate. If you don't plan on moving or refinancing, it may be in your best interest to consider having a prepayment penalty on your mortgage.
Make sure you ask and are completely aware of any pre-payment penalties on your loan before you get to closing. If you are choosing to go ahead with an adjustable rate mortgage (ARM) you should make sure that your pre-payment penalty does not exceed your fixed rate portion or your loan. An example would be if you choose a 2/28 ARM (rate is fixed for 2 years and then adjusts every year thereafter for the next 28 years) you probably do not want to have a 3, 4, or 5 year pre-payment penalty on your loan. Many times after your fixed portion of your ARM is up you will choose to refinance to either another ARM loan or a fixed rate loan and you don't want to get stuck still having a pre-payment penalty.
Lenders that have pre-payment penalty features on their loans generally do not like to have their pre-payment penalties bought out. The number one reason for taking a considerably higher rate to avoid a pre-payment penalty is because you are planning to sell the house quickly or refinance to a new loan quickly. Lenders prefer for you to stay in your mortgage with them for long periods of time so that they can earn more money. By applying prepayment penalties to loans, the lenders can keep their borrowers for longer periods of time on average. Some people will still sell or refinance again before their prepayment penalty period is up, however the lender will make their money then from the prepayment penalty.
If you are taking an adjustable rate mortgage (ARM) with a prepayment penalty make sure that the penalty is not longer than the fixed period of the ARM because some arms may go up between 5 and 6% after the initial adjustment and at that point it would be in your best interest to be able to refinance without penalty after the initial fixed period.
Consult with your mortgage professional to see what the differences are in terms for varying prepayment penalty options. Ask what you can do to qualify for Fannie Mae, FHA, or VA financing. These programs do not have prepayment penalties.
Some states have laws specifically prohibiting pre-payment penalties. Other states have laws that limit pre-payment penalties. Be sure to ask your preferred mortgage professional about the laws in your state.
If you do choose to accept a pre-payment penalty make sure you review the terms of the penalty at the closing. There are different amounts and calculations for the penalty that can be assessed. Sometimes it is six months worth of interest, or it could be a percentage of the balance. There are also different terms for what is considered pre-payment. It might only be considered pre-payment if you pay the loan off in full and sometimes it is if you pay down more than 20% of the balance in any 12 month period.
Is a prepayment penalty tax deductible? - If you have a mortgage with a prepay penalty, the prepayment penalty is tax deductible because it is an interest charge. Different rules apply if it is an investment property.
Never choose to refinance your mortgage looking for the tax benefit. A pre-payment penalty is tax deductable, however, if you are refinancing and your pre-payment penalty is $8,000 and you're refinancing to save $100 a month on your payment, you won't reap the benefit of the refinance until 6 1/2 years from the time you refinanced.
Take the time to look at your note on your current loan to see when your pre-payment penalty expires. A prepayment fee is tax deductible, but you may be better off in some cases waiting if the pre-payment penalty period is due to expire shortly.
The Tax deduction is only one factor in making the decision on whether or not to pay a pre payment penalty to refinance. You should also weigh the non-tax benefits of refinancing with your financing professional, whether it be obtaining lower payments, high interest credit card debt consolidation or separating cash from home equity with a cash out refinance.