Early Repayment – The Good and The Bad

Having just paid off my last credit card, I know what it’s like to get that monkey gorilla off my back. The sky is bluer, the birds sing louder, and the air I’m breathing is fresher. Paying off the credit cards meant budgeting them in—and for me that meant paying off
amounts that possibly cut it close to me in terms of how much cash on hand I would have for other emergencies (without touching my savings, anyway). But other types of loans are not that easy to pay off—not because you can’t just pay it off but because some loans payoffs come with a penalty called an ‘early repayment penalty.’

Mortgage Prepayment Penalty
Mortgage prepayment penalties are probably the most common type of prepayment penalty, largely due to the fact that over the life of the loan the interest paid by the mortgagee is clearly a substantial amount.  Prepayment penalties are usually a percentage of the outstanding balance, but can also be expressed as an amount based on the interest that would normally be paid over X amount of months.

Should You Accept a Prepayment Penalty in Your Contract?
The answer to the question depends on your circumstance. If, say, you are a prime borrower (meaning you have good credit, are putting down 20% or so, and are planning on being a responsible borrower, etc.), then a prepayment penalty may make sense if part of the agreement is that your rate will also be lowered, be it ¼ percent or even a ½ percent. If you look at it from the lender’s perspective, it makes sense as well. Even though they are providing you with a lower rate (and thus lower payments to them), they’re covered by the early payment penalties. If rates drop and thus make it attractive for homeowners to refinance, you’re already at a lower rate to begin with, so the chances of you going out and looking for a better deal are already that much less.Of course, if you’re a prime borrower you may balk at the prepayment penalty, because you’re not really the risky ones the lenders are worried about. So you may, unfortunately, never even be offered to have a prepayment penalty.

Sub-Prime Borrowers and Prepayment Penalties
Sub-prime borrowers, or borrower with less-than-stellar credit scores and thus less leverage when it comes to negotiating mortgage rates, don’t have as many options available to them as prime borrowers, especially these days, when subprime lenders have headed for the hills.Prepayment penalties will likely be written into contracts for subprime borrowers, and because of their status as a subprime borrower will probably not be able to talk their lender out of having one in the contract.But never fear—your loan could also be your opportunity to improve your credit rating, and thus lower the rate you pay on your mortgage. Have the discussion upfront, prior to signing any papers. Tell your lender that you’d like to lower your rate after 2 years of payments, or some other amount of time.

FHA, VA, and Prepayment Penalties
If you have an FHA or VA loan, you’ll never have a prepayment penalty. Why? Because the law says you can’t. This also applies to Federally chartered credit unions. Do your research, however, because there are plenty of laws that I have not mentioned here—do your work!I hope this above has provided you with some insight into prepayment penalties, what you should avoid and what to do if you have to include a prepayment penalty clause just to get a loan. Go in after doing your homework—it’ll save you headache and money in the long run.