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.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 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 receive 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.
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.
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.
Home
