Mortgage Prepayment Penalty Provision

By signing a mortgage contract containing a prepayment penalty clause, the borrower is agreeing to a charge the lender will make when a mortgage is repaid before a certain period of time. In effect, the borrower is “penalized” for paying off his or her mortgage early.

Lender’s Perspective

A prepayment penalty helps the lender recoup some or all of the significant expense which occurs in putting a new loan on the books. If the loan is to be repaid quickly, such as by refinancing elsewhere, the lender can incur a loss from not having time to make up the costs it advanced. Lenders also know a mortgage prepayment penalty discourages prepayment. As a practical matter, prepayment penalties decline or disappear over the passage of the loan’s life. Rarely do prepayment penalties apply after the fifth year of a loan’s existence as a general rule. Partial pre-payments up to twenty percent (20%) of the existing loan’s balance are usually allowed in any one year by the borrower without any penalty. Rarely are prepayment penalties waived by the lender after the loan documentation is signed by the lender and borrower and the loan is received.

Mortgage Prepayment Penalty Provision

A prepayment penalty clause must be clearly set forth in all loan paperwork to the borrower, as required by federal truth in lending requirements. When a loan has a prepayment penalty expressly tied to it in writing, the consumer benefits from an interest rate that is typically reduced by 1/8% compared to a loan that does not have a prepayment penalty.

Negotiating the Prepayment Penalty Clause

Consumers need to carefully read all loan documentation before signing. Many times there are express prepayment penalties in the paperwork. The borrower should understand that he can negotiate with the lender any prepayment penalty provision as to its length of time, its amount, or even if the loan will have a prepayment penalty provision. The lender wants the loan to go through with the borrower, and if the consumer indicates he will go elsewhere for a loan, the lender may waive the prepayment penalty provision.

A borrower should ask any questions about the loan documentation with his mortgage broker and escrow officer before the loan closes. Under federal law, a borrower has three days after loan documents are signed at escrow to cancel the loan without a penalty.