Prepayment Penalty

A prepayment penalty is an extra payment due the lender if the mortgage is repaid ahead of schedule. Due to recent mortgage reforms, prepayment penalties have been largely disallowed.

Prepayment penalties usually take one of two forms – a specific number of months’ interest, or a percentage of the remaining loan amount.

Under recent mortgage reforms, a prepayment penalty is allowed only if all of the following are true.

• The loan must have a fixed rate.
• It must be classified as a “qualified mortgage,” a “plain vanilla mortgage without risky features.
• It cannot be classified as a “higher-priced” mortgage.

There are two kinds of prepayment penalties that apply if a loan with a penalty is paid off in its first few years. There are “hard” prepayment penalties, which are assessed if the loan is prepaid for any reason, and “soft” prepayment penalties, which only apply if the loan is prepaid with a mortgage refinance. If the home is sold, no penalty applies.