Is There a Penalty If You Pay Off Your Mortgage Early?

Paying off your mortgage early can seem like a great idea After all, who wouldn’t want to own their home free and clear and stop paying interest sooner? However, before rushing to pay off your mortgage ahead of schedule, it’s important to make sure you understand if there’s a prepayment penalty and how that could impact your payoff plans.

What is a Prepayment Penalty?

A prepayment penalty is a fee some mortgage lenders charge when you pay off your loan early, either partially or in full. It provides compensation to the lender for interest they miss out on when you pay down the loan faster than its full term.

Prepayment penalties are typically only charged during the first 3-5 years of the mortgage. After that initial period, you can usually pay off the balance without penalty The fee amount varies but may equal a few months’ interest or a percentage (such as 1-5%) of the remaining principal balance.

Why Do Lenders Charge This Fee?

Lenders include prepayment penalties in loans to ensure they receive the expected interest earnings over the full loan term. Especially with lower rate mortgages, lenders rely on collecting interest over 15-30 years to earn an adequate return and offset their risk.

If borrowers pay off loans faster than expected, the lender misses out on anticipated interest – so the penalty compensates for that lost revenue.

How to Avoid the Prepayment Penalty

The best way to avoid prepayment penalties is to avoid loans that include this clause altogether. Many lenders, including some notable national brands, do not charge prepayment penalties at all.

When shopping for a mortgage, ask lenders specifically if they charge this fee and under what terms. If you’re already in a loan with a prepayment penalty, find out exactly when that period ends so you can plan to pay extra or refinance after that date.

You may also look into recasting your mortgage. This adjusts your payment amount without triggering the penalty.

Additionally, research your state laws. Some states ban or limit prepayment penalties, so your loan may not allow the fee even if the lender typically charges it.

What Happens If You Trigger the Fee?

If you end up with a prepayment penalty, the lender will simply add the charge when you pay off the balance. So you would pay your remaining principal, any accrued interest, and the penalty amount as a lump sum.

For example, if you had a $200,000 balance and the penalty equaled 3 months’ interest, you may owe around $205,000 as a full payoff.

While certainly not ideal, in some cases it still makes sense to pay the penalty and pay off the mortgage early anyway. But understanding the prepayment penalty implications before paying extra can help you make an informed decision.

Strategies to Minimize or Avoid the Penalty

Here are a few smart strategies for avoiding or minimizing a prepayment penalty if you want to pay off your home loan early:

• Ask the lender to waive the prepayment penalty or negotiate a lower fee.

• Wait until the penalty period ends, then pay in full or refinance. Time your payoff carefully.

• Recast the loan to lower payments without refinancing or paying down principal.

• Pay extra monthly but keep the payments low enough to avoid triggering the penalty.

• Sell and move out before paying off – selling the home typically doesn’t trigger the fee.

• If moving, rent out the home rather than selling. This lets you collect rental income and pay down the mortgage over time without penalty.

The Bottom Line

Prepayment penalties allow lenders to collect expected interest earnings but can deter borrowers from paying off mortgages early. Check your loan documents to see if your lender charges this fee and understand how to avoid or minimize it. That ensures you make fully informed decisions when weighing the pros and cons of paying off your home loan ahead of schedule.