Mortgage prepayment penalties may come as a surprise to many people when they think of refinancing or selling their homes. Most people don’t get to see the mortgage papers until closing and they usually don’t read all the provisions of the note before signing it. There are so many important things to do and so many papers to sign at closing that reading the fine print does not seem important.
Moreover mortgage prepayment penalty comes into effect only when the need for refinance or selling the home arises in future. At the time of applying for or signing the mortgage such things as mortgage prepayment are furthest from the mind of the borrower.
To understand how to avoid mortgage prepayment penalties you must know why and how they operate. When the borrower’s income increases, it seems like a good idea to repay the mortgage loan whithin a shorter period than originally stipulated in the mortgage agreement. By paying the mortgage before time the borrower owns the home earlier and also becomes debt free earlier.
A borrower who had to accept higher mortgage rates or what is known as sub prime lending rates due to bad credit may want to refinance the home with other lenders offering lower rates, as soon as his or her credit rating improves to reduce the mortgage interest burden. Family and other circumstances may also force the buyer to sell the home earlier.
However such things are not favorable for the lender. The lender earns money from the mortgage interest paid by the borrower and when the borrower pays of the mortgage earlier the ortgage company loses potential income. The mortgage company receives less than expected interest income on the mortgage. This is why lenders want to discourage borrowers form paying off their mortgage loans earlier.
By charging mortgage repayment penalties the lender tries to discourage the borrower from paying earlier and to compensate for the loss of income. Lenders know that if and when your credit improves, you would like to refinance to obtain lower mortgage interest rates and this can result in a loss for the lender. Therefore, lenders usually require sub-prime borrowers with low down payment or less favorable credit rating or both to agree to a mortgage prepayment penalty clause.
Mortgage prepayment penalty is a clause in your contract which stipulates that you will have to pay a penalty in case you repay your mortgage fully before time. mortgage prepayment penalty is usually charged in two ways: either as a percentage of the loan balance at the time of repayment or it is based on the actual number of months left in the life of the loan. There are two types of prepayment penalties – hard and soft. In the case of soft penalty you are allowed sell but incur a penalty if you refinance. In a hard penalty you can neither sell or refinance the property without a penalty.
Even if your credit rating is good sometimes borrowers with good credit ratings and payment records are also offered the option of availing mortgage prepayment penalty, by banks, so that their interest rate is lowered and they have to pay a lower monthly mortgage. Whether you should agree to this depends on the rate of penalty and whether you are likely to sell your house in the future.
Usually the mortgage prepayment penalty clause says that if the borrower pays off the loan before time, this period is commonly the first five years of the loan, then the borrower is liable to pay an additional amount of 6 months interest on 80% of the balance mortgage. This is typical for sub prime borrowers but it may vary from lender to lender. Usually however lenders allow you to pay up to 20% of the mortgage balance in a single year and avoid mortgage prepayment penalty.
The best way to avoid mortgage prepayment penalty is of course at the beginning. If you are a prime borrower it will be easy to waive this clause. Always ask what happens if you sell you home or refinance it earlier or if you make advance payments. If there is a prepayment penalty then you will know about it. If you are a sub-prime borrower then it may be difficult to waive the penalty altogether. Still you can try to negotiate for better terms. You may ask for its waiver in case you sell the house.
Although it is difficult to get the penalty waived altogether once you are saddled with it there are some ways you can try to get relief. One way is to convince a court that the lender as taken you for a ride or has taken unfair advantage of you. If the court is convinced then you may be able to avoid paying penalty. However this is possible only if the lender has actually taken advantage of you. This process also can be expensive.
Another way to avoid mortgage prepayment penalty is to convince the lender to swap the old penalty period for a new one by getting the mortgage refinance by the same lender. In case you are planning to sell the property if you can get the buyer to use the same lender for mortgage you may be able to convince you lender to waive the penalty. Also if they buyer has a considerable amount of clout with the lender he or she may be able to persuade your lender to waive the mortgage prepayment penalty.
A way to avoid prepayment penalty at the beginning is to pay points on the loan, if you have cash in hand. The points are a type of fees that you pay upfront to the lender for getting better interest rates or terms that are more favorable to you. By paying this fee you may be able to persuade the lender to drop the prepayment penalty. However if you are already saddled with it you may try to take out an equity loan if you need money.
You may also be able to take the help of a powerful community group to intercede on your behalf and persuade your lender to rewrite the note. In some cases the inaccuracies in the credit report may lower the borrower’s credit and make it difficult for the borrowers to avoid mortgage prepayment penalty. Therefore it is always prudent to keep track of your credit score and get your free report regularly to keep track of any inaccuracies or unauthorized activity. Once the inaccuracies are corrected and your credit score improves you may be able to avoid mortgage prepayment penalties.