By Justin McHood
NEW YORK (Zillow) —
Although not as common as they were just a few years ago, there are still various loan programs that give people an option to have a prepayment penalty.
If you get a mortgage that has a prepayment penalty, it means that you are agreeing in writing that should you “prepay” the mortgage before a specified period of time (usually less than 5 years) then you agree to pay a specified “penalty” to the lender. Some prepayment penalties require you to agree to the penalty only under certain circumstances (for example, you may not have to pay if you sell your house), others require you to pay the penalty regardless of the reason you prepaid the mortgage.
When a lender agrees to loan you money, they have calculated their expected return on the mortgage and built it into their models, even calculating the period of time that they expect you to have the mortgage before it “prepays.”
Although winning the lottery happens, the most common reason that someone would prepay a loan off before the maturity is that they were able to find a loan offered by another lender with a lower interest rate and refinanced out of their current mortgage and into a new mortgage.
When interest rates drop, many people refinance and prepay numbers go up dramatically.
How To Tell If You Have A Prepayment Penalty On Your Mortgage
The easiest way to find out if you currently have a prepayment penalty is to dig out the paperwork you have from when you signed your final paperwork and look for your mortgage note. Most often, there will be wording in your note that outlines the prepayment penalty terms. Sometimes there will also be something called a “Prepayment Penalty Rider,”, but it will vary depending on when you closed your loan and your lender.