Do you have less-than-sterling credit? Watch out for pre-computed loans, in which interest is front-loaded, ensuring the lender collects more in interest no matter how quickly you pay off the loan.
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If a loan has a prepayment penalty, the servicer must include information about the penalty on either your monthly statement or in your loan coupon book (the slips of paper you send with your payment every month).
First, check your contract.
“They avoid using the word ‘penalty,’ obviously, because that would give a reader of the note, mortgage or the loan some alarm,” he said.
The loan is considered a “qualified mortgage” (meaning it can’t have features like negative amortization or interest-only payments).
What Is a Loan Prepayment Penalty?
Most loans do not include a prepayment penalty. They are typically applied to larger loans, like mortgages and sometimes auto loans — although personal loans can also include this sneaky fee.
Credit unions and banks are your best options for avoiding loans that include prepayment penalties, according to Charles Gallagher, a consumer law attorney in St. Petersburg, Florida.
Additionally, although you may get socked with a penalty for paying off the loan balance early, it’s likely you can still make extra payments toward the balance. Review your contract or ask your lender what amount will trigger the penalty, Gallagher said.
A prepayment penalty is a fee lenders charge if you pay off all or part of your loan early.
What Loans Have Prepayment Penalties?
Well, in some cases, yes.
By using techniques like the debt avalanche, debt snowball and debt lasso methods, you can tackle your other debts while giving yourself time to let a prepayment penalty period expire.
“It’s more of private loans — loans for people who’ve maybe had some struggles and can’t qualify for a Fannie or Freddie loan,” Gallagher said. “That block of lending is the one going to be most hit by this.”
If you don’t have a loan with a prepayment penalty, contact your lender before sending additional money to ensure your payment is going toward principal — not interest or fees.
Prepayment Penalties for Mortgages
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Prepayment penalties apply for only the first few years of a mortgage — the CFPB’s rule allows for a maximum of three years. But again, check your mortgage agreement for your exact terms.
The loan has a fixed interest rate.
If you’re negotiating the terms — as say, with an auto loan — don’t let a salesperson try to pressure you into signing a contract without agreeing to a simple interest contract with no prepayment penalty. Better yet, start by applying for a pre-approved auto loan so you can get a pro to review any contracts before you sign.
- If you do discover that your loan includes a prepayment penalty, you still have some options.
- Typically, a prepayment penalty only applies if you pay off the entire balance – for example, because you sold your car or are refinancing your mortgage – within a specific timeframe (usually within three years of when you accepted the loan).
- If your lender presents you with a contract that includes a prepayment penalty, request a loan that does not include a prepayment penalty. The new contract may have other terms that make that loan less advantageous (like a higher interest rate), but you’ll at least be able to compare your options.
Gallagher rattled off a list of alternative terms a lender could use in the contract, including:
That prepayment penalty can apply if you want to pay off your loan early, sell your house or even refinance, depending on the terms of your mortgage.
So suppose you bought a house last year and then wanted to sell your home. If your mortgage meets all of the above criteria and has a prepayment penalty clause in the mortgage contract, you could end up paying a penalty of 2% on the remaining balance — for a loan you still owe 0,000 on, that comes out to an extra ,000.
The best way to avoid a prepayment penalty is to read your contract — or better yet, have a professional (like an attorney or CPA) who understands the terminology, review it.
How to Find Out If a Loan Will Have a Prepayment Penalty
The Consumer Financial Protection Bureau ruled that for mortgages made after Jan. 10, 2014, the maximum prepayment penalty a lender can charge is 2% of the loan balance. And prepayment penalties are only allowed in mortgages if all of the following are true:
But you can avoid the trap — or at least a big payout if you’ve already signed the loan contract. We’ll explain.
”The more opportunistic and less fair lenders would be the ones who would probably be assessing [prepayment penalties] as part of their loan terms,” he said, “I wouldn’t say loan sharking… but you have to search down the list for a less preferable lender.”
- Sale before a certain timeframe.
- Refinance before a term.
- Prepayment prior to maturity.
Look at you, so responsible. You received a financial windfall — stimulus check, tax refund, work bonus, inheritance, whatever — and you’re using it to pay off one of your debts years ahead of schedule.
A prepayment penalty is a fee lenders use to recoup the money they’ll lose when you’re no longer paying interest on the loan. That interest is how they make their money.
However, if there is a prepayment penalty in the contract for a more recent mortgage, there are rules about how long it can be in effect and how much you can owe.
Unfortunately, if you have bad credit and can’t get a loan from traditional lenders, private loan alternatives are the most likely to include the prepayment penalty.
How Can You Find Out if Your Current Loan Has a Prepayment Penalty?
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If you’re paying off multiple types of debt, consider paying off the accounts that do not trigger prepayment penalties — credit cards and federal student loans don’t charge prepayment penalties.
What to Do if You’re Stuck in a Loan With Prepayment Penalty
The prepayment penalty won’t apply to FHA, VA or USDA loans but can apply to conventional mortgages — although the penalty is much less common than it was before the CFPB’s ruling.
Prepayment penalties do not normally apply if you pay extra principal in small chunks at a time, but it’s always a good idea to double check with the lender and your loan agreement.
You can also ask your lender about the terms regarding your penalty by calling the number on your monthly billing statement or read the documents you signed when you closed the loan — look for the same terms mentioned above.
Good for you! Except… make sure you don’t get charged a prepayment penalty.
If you’ll incur a fee for paying off your loan early within the first few years, consider holding onto the money until the penalty period expires.
The loan’s annual percentage rate can’t be higher than the Average Prime Offer Rate (also known as a higher-priced mortgage).
Now wait just a minute, you say. I’m paying the money back early — early! — and my lender thanks me by charging me a fee?
In some cases, a prepayment penalty could apply if you pay off a large amount of your loan all at once. <!–
If your loan includes a prepayment penalty, the contract should state the time period when it may be imposed, the maximum penalty and the lender’s contact information.