Should I accept a Pre-Payment Penalty with my mortgage

A prepayment penalty is a provision of your mortgage contract with the lender that states that in the event you pay off the loan entirely, you will pay a penalty. Penalties are usually 6 months of interest on the unpaid principle balance. The maximum penalty time is 5 yrs. The time period varies depending on the type of loan the borrower decides on. Partial prepayments of up to 20% of the balance per year are usually allowed without paying any penalty. A penalty that applies to a home sale as well as refinancing is called a "hard" prepay; if it applies to only a refinance it's called a "soft" prepayment penalty.

Why Would I Accept a Prepayment Penalty?

Two reasons come to mind. If you are certain you will not need to refinance or sell in the next 3 to 5 years, depending on the prepayment penalty term, you may be able to save monthly on your payment. Most sub-prime loans allow a loan officer to negotiate a lower rate by including a prepayment penalty option. You must be very careful when encouraging a loan officer to negotiate a prepayment penalty option for you. Certain loan officers have been known to take advantage of the borrower by including a prepayment penalty to increase the amount of commission he will receive. Always ask the loan officer if he will be receiving an additional rebate by accepting the prepayment term. It's easy to find out when you sign your loan documents if he/she has told the truth. It will be included on the estimated closing sheet provided by the title company. The information will often appear hidden on the form. Just ask the escrow officer to show you where the rebate, if any appears on the form. They are required to advise you. An additional reason to accept a prepayment penalty is when there are credit issues. This may be the only way to be approved for a loan. If this is the case, you will have a few years to re-establish a good credit rating. I would highly recommend a solid strategic plan prior to accepting this type of loan. An experienced and ethical loan agent can help guide you on what needs to be incorporated in the "plan". They should follow up with you on a regular basis to make sure you stay on task. Having a credit report ran by the loan officer once a year is not a bad idea. In my opinion, this should be apart of the service they provide to you just by being a client.

Can The Prepayment Penalty Be Waived?

Lenders rarely have a reason to waive a prepayment penalty. If you refinance with the same lender, they may forgive the prepayment, but I can guarantee they will add a prepay penalty on the new loan. It will be for 5 yrs. If you are selling your home or refinancing with a different lender, your chances are not good considering you are terminating a relationship with them to start anew with another lender, why would they?

Can a Prepayment Penalty Be a Tax Deduction?

Unforeseen circumstances often cause borrowers to pull out of their mortgages sooner than expected. Fortunately, pre-payment penalties are tax deductible, which helps ease the pain. Check with your CPA.

You need to evaluate your current and future situation very carefully when deciding on loan terms. Make sure you use an experienced and ethical loan officer to represent you. Whether your loan officer is employed by a broker or a bank, they need to have your best interest in mind when advising you.