How to calculate mortgage prepayment penalty?Answer:
The first thing you need to know before calculating your mortgage prepayment penalty is to find out the terms of the penalty. You need to look at your closing documents, specifically, the prepayment penalty rider which spells out the terms and conditions of the application of a prepayment penalty.
Mortgage lenders set various types of prepayment penalties and there is no single formula for calculation of a prepayment penalty for every client's mortgage. There are, however, two common types of prepayment penalties and we'll show you how to calculate them.
6 Months Interest on Mortgage Prepayment Penalty:
This is probably the most common type of prepayment penalty that lenders use in mortgage agreements. It is calculated as six months of interest on 80% of the current outstanding balance.
Consider the example of a mortgage with 5% annual interest rate and $200,000 outstanding balance. Six months worth of interest would be half of the annual rate, i.e. 2.5%. So we multiply 2.5% with 80% of the remaining balance and find out the prepayment penalty.
PP = 2.5% * 80% * $200,000
PP = $4000
X% of Outstanding Mortgage Balance Prepayment Penalty
This type of prepayment penalty is usually structured in a way that in the initial years the penalty percentage is highest and then it reduces by 1% every year until it becomes zero.
Calculation is very simple as all you have to do is calculate a percentage of the outstanding balance.
A few Tips when Calculating Mortgage Prepayment Penalty
- First find out whether the penalty applies to you or not. Some prepayment penalties expire after a period of time and others apply only on refinancing and not on sale of the house.
- Use your loan statement to find out your outstanding balance. This is the figure you should use for your calculations.
- Contact your lender to check if you can get the penalty waived. Even though it is a very rare case, there is no harm in trying.
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