Loan Rates: Are Prepayment Penalties Actually A Good Thing?
When shopping for the best home loan rates, are pre-payment penalties really a good thing?
In the past home buyers and home owners seeking refinance or purchase mortgage loans were either oblivious to what loan prepayment penalties meant, or found them oppressive. So why hasthe perception on the features of loan rates changed among more sophisticated borrowers, and why do you want one?
The Historic Downside of Hefty Prepayment Penalties
Prepayment penalties were extremely common during the years of subprime lending. In fact, they were pretty much the norm. However, many soon found these financial penalties took a significant toll when it came time to sell their homes and move up, or mortgage loan rates dropped and they wanted to refinance. If they did this too soon after taking out a mortgage it often meant handing over a significant chunk of equity. As the market rose some of the hardest hit were those with reverse mortgages who had never expected to come into such a windfall of equity or live so long. As the housing market dipped many found these provisions held them back from selling fast and kept them further underwater. However, now that we are in a new upward real estate cycle, and buying property is on the top of most individual’s to-do lists experienced investors and homeowners are looking at prepayment penalties in a new light.
Why You Want a Prepayment Penalty
A pre-payment penalty means that if you pay off your home mortgage early you pay a monetary penalty at the closing. This might be a fixed percentage which declines and then expires after the first few years, or it could be attached for longer periods and be based on a more complex calculation depending on the type of financing you are taking out. These features are used by lenders to guarantee a fixed rate of return for them and secondary market investors.
Pre-payment penalties can often be waived and negotiated out by accepting slightly high loan rates, or paying points at closing which achieve the same objective. This can be smart for those that plan to sell or refinance their properties in the next few years.
However, in the reverse; for those planning on staying put, and keeping their properties or loans for the long run, asking for a pre-payment penalty can help reduce upfront closing costs and obtain lower loan rates for the life of the loan. This can mean paying far less interest, and enjoying lower monthly payments.
The key is to select a pre-payment penalty that works for your situation and timeline. Always make sure to read the fine print and ask questions until you are comfortable that you completely understand how loan rates will be calculated and how much it will cost at any given time.
Finally; for those that have loans with prepayment penalties now, and find they are holding them back from selling or refinancing it may be worth looking into negotiating it down, or finding someone to assume the loan.