Dealing With The Prepayment Penalty In Your Mortgage

The prepayment penalty clause in a mortgage is about the equivalent of stealing from your own mother. It’s one of the most horrible things on earth! The prepayment penalty became popular during the real estate boom when many people bought houses with subprime adjustable rate mortgages, and many lenders secretly added the prepayment penalty of death. Okay, maybe I’m being a little too dramatic. After all, it’s just a mortgage. If you have a prepayment penalty, then your lender probably stuck you with a subprime loan. Most prime rate loans should not include the prepayment penalty.

What is it?

Basically, a prepayment penalty is exactly how it sounds. Your lender will charge you a flat fee for paying off the loan too quickly. Let’s say you bought a home with an ARM or a loan with a really high rate, and now you want to refinance it. If you do this during the specified time period of the prepayment penalty (typically within the first 5 years of taking out the mortgage), then the lender will charge you anywhere from a percentage of the total loan amount to 3 – 6 months worth of interest. I told you it was horrible. You mean a mortgage company will actually penalize me for paying off my mortgage? Of course! They only make money off the interest you pay them every month. My guess is that lenders knew that consumers of subprime loans would realize how horrible their mortgage was, so the lender decided to start throwing in the prepayment penalty. It’s the same concept as credit card companies realizing that consumers were card hopping from one 0% interest rate card offer to another, so they threw in the 3% balance transfer fee.

What are my options?

There are three options. You can pay the penalty and refinance/sell your home, keep the mortgage and take the risk of the interest rates not rising too much in the future, or negotiate with your lender to have the prepayment penalty waived. The choice you make depends on the size of your prepayment penalty. If we’re talking $4,000 to $6,000, then my suggestion would be to take the risk of your interest rate not rising too much. You can do the math on your own. Figure out what 1 percentage of interest per year equals to and compare it to what your prepayment penalty would be.

The power of asking never hurts either. Chances are that most lenders will laugh in your face when you ask them to waive the prepayment penalty. You signed the contract, and it’s your responsibility to know what you are signing. However, I’ve heard of companies doing weird things. Recently, we went over on our cell phone minutes and T-mobile was more than happy to take the fees off for going over just because we had never gone over before and I have been a customer with them for about four years now. Be a pest. What do you have to lose? Call them and plead your case. If the first guy says “no”, ask for his boss. If that guy says “no”, ask for his boss. Honestly, what do you have to lose? Don’t think of it as trying to cheat the system. Companies fees are pure profit. Do think credit card companies lose money if they waive a late payment fee? It’s the same way with mortgage companies. They aren’t losing out on anything by waiving your prepayment penalty. Like I said, the chances are slim, but you never know what could happen.

Know what you are getting into

Shelling out the money for a prepayment penalty might be what you need to help you start becoming more of an educated consumer. Know what you are buying when it comes to financial products whether it’s a mutual fund, insurance policy, or mortgage. Before you sign that dotted line, do research online and know what types of questions to ask the salesperson. If you had known about prepayment penalties before you bought the mortgage, would you have asked about it before signing on the dotted line? Dave Ramsey has a term called “stupid tax”. He says that everyone pays a stupid tax in their life. It’s any kind of fee or payment you make that you probably could have avoided if you had known better. The prepayment may be your stupid tax, but don’t let it ruin your day. It happens to the best of us.

Do any of you have a story about a prepayment penalty? Post a comment about it.

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