Question:

What are the different prepayment fees on mortgage loans?

Answer:

Prepayment fees serve to protect lenders when market rates are dropping. A mortgage prepayment fee was usually used to protect lenders of fixed rate loans, as borrowers had a great incentive to refinance when market rates would fall.

Adjustable rate loan prepayment supposedly didn't pose such risk to lenders, as the floating rate was said to spread the risk between the lender and the borrower. However, consumers nowadays tend to refinance every so often. Well, not every type of consumer, but there are many who'd refinance on a regular basis to cut their rate, or manage to pay off their mortgage on accelerated terms before the projected amortization schedule.

Prepayment Charges on Mortgages Serve the Lender

One specific reason for charging loan prepayment fees is to cover certain upfront charges made by the lender to underwrite the mortgage loan. Another reason for lenders to charge prepayment penalty fees is to offset the loss of expected income.

Percentage-Based Prepayment Fees

Yes, your prepayment fee could be in cash. But it is more likely to be expressed as a percentage of the loan amount, or unearned interest for several, usually 6, months.

For a mortgage loan with $200,000 principal the prepayment charge may be set up at 4% if prepaying in the first year and 1% less for every year thereafter. That way, in the 3rd year of the loan the borrower will be required to pay 2% (or $4000) if they prepay the mortgage. Paying off the loan early in the 5th year would incur no charges for that borrower.

If the loan of $200,000 was taken at 6.5% for 30 years, the prepayment fee could be set at the interest owed on the loan over the next 6 months. In the early years of the loan this could be well over $5-6000.

Mortgage rates hit their lowest since 1955. Ask the home loan experts we recommend Quicken Loans how to take advantage of them.
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