Mortgage Pre-Payment Penalty
One will find many lenders who lure naïve borrowers with slightly lower interest rate in exchange for a mortgage pre-payment penalty. A mortgage pre-payment penalty is a penalty imposed on the borrowers when he wants to payoff his home loan early.
Usually a borrower is unaware of the actual meaning of the penalty and ends up agreeing to the terms and conditions imposed by the lender in order to save a little money on the lower interest rate. What the borrower does not realize that a mortgage pre-payment penalty can actually end up costing him tens of thousands of dollars.
Lenders use the mortgage pre-payment penalty to secure loans long enough to recover some or all of the expenses they incur when they originate the loan. Lenders also know that a mortgage pre-penalty will not allow refinancing. So, if the interest rates fall, lenders are certain that they will get a high rate of return on the money that was lent to the borrowers.
There are some borrowers who agree to the pre-payment penalty because the time frame matches the duration they intend to keep the loan. However, they forget that the future is completely unpredictable. A borrower who suddenly has to move or gets transferred to another state or city is then saddled with the pre-payment penalty because if he tries to sell the home before the period of the penalty is up, he would have to pay a huge amount to the lender.
In the US, there are a few states that do not allow lenders to levy a pre-payment penalty. You should check with your lender whether you are presently living in one of those states. However, one needs to be careful as some banks work under the federal law and not the state law, and they could charge a borrower mortgage pre-payment penalty.
Usually a mortgage pre-payment penalty is equal to a percentage of the outstanding balance of the mortgage at the time pre-payment is done. Some times, lenders calculate the mortgage pre-payment penalty as specified number of months of interest. Therefore, home buyers and mortgage borrowers are constantly advised by experts to think twice before agreeing to a mortgage with a pre-payment penalty clause even if the interest rate seems very attractive.
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