Mortgage Prepayment Penalty Fees: Guide to Understanding and Avoiding Them (2024)

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• A mortgage prepayment penalty is a fee for paying off your home loan early.
• You'll likely only pay a fee if you pay off the mortgage within a few years of initially taking out the mortgage.
• You won't pay a prepayment penalty on USDA, VA, or single-family FHA mortgages.

There are pros and cons to paying off your mortgage early. On the bright side, you'll lower your monthly payments and save money on interest. You'll also free up cash flow to put toward other goals.

However, paying off the home loan early may come with a lesser-known fee: a mortgage prepayment penalty. Here's what to know about this fee and its potential cost.

What is a mortgage prepayment penalty?

Before you pay off your mortgage loan early, you'll want to know if your lender charges a mortgage prepayment penalty — and how much it may be.

Definition

A mortgage prepayment penalty is a fee you pay the lender if you pay off your mortgage, sell your house, or refinance your home within a certain amount of time of closing on your initial mortgage — usually three to five years.

Mortgage prepayment penalties aren't all that common these days, but there's still a chance you could owe one. You probably wouldn't if you paid extra toward your mortgage every month or made supplemental payments here and there. You could, though, if you either a) pay off the mortgage completely by making a large payment, selling, or refinancing, or b) pay off a huge portion of your mortgage all at once before a certain date.

Purpose

If you pay off your mortgage super early, like within a few years of taking out your loan, the lender misses out on up to tens of thousands of dollars you would have paid in interest over the years.

If you refinance, you could go through a different mortgage refinance lender. If you sell, there's a good chance the buyer will use a different lender. Regardless, your current lender would miss out on money.

A prepayment penalty may discourage you from paying off your mortgage early, so the lender gets to keep your business. If you do pay off the loan early, the lender at least offsets that loss by a little bit.

Types of prepayment penalties

There are two types of prepayment penalties: Soft and hard. Here's how those differ.

• Hard prepayment penalties: With a hard penalty, you'll pay a fee if you sell or refinance your home.
• Soft prepayment penalties: With a soft penalty, you'll only pay if you refinance — but you can sell at no extra cost.

The terms of your prepayment penalty will be included in the documents you sign at closing, but your lender should inform you about penalties well before then. If a lender provides a mortgage that includes prepayment penalties, it is also legally required to offer you an alternative mortgage that doesn't charge penalties. If you're already in the homebuying process and your lender hasn't brought up the subject yet, don't be afraid to ask.

How much is a mortgage prepayment penalty?

Each lender has its own methods for charging mortgage prepayment penalties. Here are some possibilities:

Varying amounts

Prepayment penalties can vary quite a bit from lender to lender and loan to loan. Factors like the loan type, the outstanding balance, and the remaining loan term can all play a role.

Percentage-based penalties

These fees amount to a percentage of the remaining mortgage when you sell or refinance. Let's say you still owe $100,000 when you refinance your home, and the prepayment penalty is 4%. You'd pay 4% of $100,000, or $4,000.

Fixed amount penalties

These are flat fees set by the lender. Maybe you'd pay $500, regardless of when you pay off the mortgage or how much of the mortgage is left when you refinance.

Interest-based penalties

These penalties charge you a certain amount of lost interest. For example, you might have to pay six months worth of interest.

When do prepayment penalties apply?

Prepayment penalties aren't a given. They only apply in certain situations and on certain loan types, For example, lenders legally can't charge prepayment penalties on most government-backed mortgages, including VA loans, USDA loans, and single-family FHA loans.

Beyond this, you'll usually only face prepayment penalties if:

Refinancing or selling

These fees can apply when you refinance your mortgage with a different lender or sell your home within a certain period of taking it out (usually the first three to five years).

Large lump-sum payments

If you make a large lump-sum payment to pay off the loan early, you may face a fee, too. Some lenders may also charge fees for making other large payments toward the principal — even if it doesn't settle your loan balance.

Check your loan documents

Not all lenders and loans charge prepayment penalties, so be sure to carefully review your mortgage documents to see if you could be on the hook for one. You can also call up your loan servicer directly.

How to avoid prepayment penalties

If you're wondering how to get rid of a prepayment penalty on a mortgage or you want to avoid a prepayment penalty now or down the line, there are several strategies. You can:

Choose a mortgage without a prepayment penalty

Many loan programs don't allow for prepayment penalties, so choose one of these — typically a government-backed one — from the get-go. You can also ask any lenders you're considering if they charge prepayment fees, particularly if you think you may want to sell or refinance fairly quickly.

Negotiate with your lender

Some lenders may be willing to negotiate with you to reduce or even remove the prepayment penalty, but you'll need to call and ask. They may be more likely to negotiate if you've made your payments on-time every time.

Wait out the penalty period

Prepayment penalties are usually only due within the first few years of the loan, so if you can, try to wait to sell, refinance, or pay off the loan until that time.

Make gradual extra payments

If you want to reduce your loan while you wait out the penalty period, you might consider making biweekly payments or making the occasional extra payment toward your principal balance. Many lenders will allow you to make a certain amount of extra payments every year without penalty.

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