How A Pre–Payment Penalty

Could Cost You A Fortune

Lenders often entice borrowers to finance a home with a slightly lower interest rate in exchange for something called a mortgage pre–payment penalty. A pre–payment penalty on a mortgage note is a penalty for paying off your loan early. But what borrowers don't fully understand when they agree to such terms is that although they may save a little on their monthly mortgage payment with a lower rate, pre–payment penalties could end up costing them tens of thousands of dollars.

Lenders use pre–payment penalties to secure loans long enough to recover some or all of the expenses they incur from originating the loan. Lenders also know a mortgage pre–payment penalty discourages refinancing. If rates should fall, lenders are guaranteed a higher rate of return on the money they lent to you. Say interest rates drop and you want to refinance to that lower rate. You can't! You end up paying your current rate while your lender likely pockets that extra money, unless you pay their fee.

Even if the duration of the penalty matches the amount of time you plan to keep the loan, you can't predict the future. What if your circumstances change and you have to move? Say your job is transferred to a different city or state. Selling that house before the pre–payment penalty period is up could cost you tens of thousands of dollars.

There are a few states that don't even allow pre–payment penalties; make sure you check with your lender to see if you live in one of those states. Though, be aware that even if you are, that doesn't necessarily mean that you won't be charged a pre–payment penalty since some banks work under federal law, not state law. Again, check with your lender.

Typically, pre–payment penalties equal a percentage of the outstanding balance at the time of the pre–payment. Sometimes they are calculated as a specified number of months of interest. Quicken Loans never charges a pre–payment penalty on any of our mortgages. It's our policy. So we recommend you think twice before agreeing to a mortgage with a pre–payment penalty, no matter how enticing that lower rate may seem.