Investors who financially back home mortgages are in the business of making money. The primary return on their investment comes from the interest paid by the borrower. However, often enough borrowers don't hold onto their mortgages for more than a couple of years and leave the investor short on their investment. One way investors have secured their ability to make a return on their money is by creating prepayment penalties on their loan products. It is important to be aware of the different types of prepayment penalties when acquiring your home loan. Too many times I have met with clients who weren't aware they had a prepayment penalty on their loan they previously acquired elsewhere.

A prepayment penalty is a type of fine for paying off your mortgage before a certain period of time. Most prepayment penalties are for periods of two or three years, five years being the legal maximum. This means that if the borrower decides to refinance or sell their property (thus paying off their existing mortgage) within the period of their prepayment penalty they will be charged an extra fee. Usually this fee is based upon six months interest of the base loan amount. For example: If your current mortgage payment is $1350 ($250 towards principal and $1100 towards interest), the prepayment penalty would be $6600 ($1100 x 6 months). This is not a small amount of cash, so you can see why it is important to know if your loan will have a prepayment penalty.

There are two types of prepayment penalties, hard and soft. A hard prepayment penalty will be initiated by the borrower either selling or refinancing their home within the fixed period of time. A soft prepayment penalty is only initiated by the borrower refinancing their home, without penalty for selling the home. Investors I work with generally don't mind a soft prepayment penalty since they intend on flipping the property (selling the property for profit in a short period of time) with no intention of refinancing in the future.

Sub-prime loans (B and C paper) commonly have prepayment penalties. These loans tend to have a little more risk attached to them, thus the investor attaches a prepayment penalty to secure the investment. Borrowers who only qualify for sub-prime loans usually don't have a choice in regards to having a prepayment penalty. They can sometimes be avoided, but in that case the interest rate is around a full percent higher. My clients who fall into this bracket often accept the prepayment penalty in order to keep their mortgage payment affordable.

More A and Alt-A paper programs are offering prepayment penalties on their loan products. Why would someone who can qualify for an A paper loan want a prepayment penalty? Accepting a prepayment penalty will generally get the borrower a lower interest rate. For the borrower who has no intention of refinancing or selling their home and wants a thirty year fixed mortgage, a three year prepayment penalty will not be an issue for them. This is something to consider thoroughly before you make a decision. Even though it seems like you might not move or sell right now, you never know what could happen in the future.

Prepayment penalties are not a complicated subject. I can't stress enough how important it is to make sure you know if your loan has one before signing. It seems to be a trick of the greedy loan officer to slip a prepayment penalty on their client's loan in order for them to make more money. Don't let this happen to you. Out of town and online lenders are notorious for not making their clients aware of prepayment penalties attached to their loans. Work with a loan officer that can be held responsible for the way they treat your financial future.