According to Freddie Mac, a mortgage with a prepayment penalty option requires you to pay a penalty or fee if all or most of loan amount is repaid within a certain time period (generally ranging from 2 to 5 years from the start of the loan). Prepayment penalties are usually expressed as a percentage of the outstanding balance (e.g., 2%) or as a specified number of months of interest--typically 6 months of interest if paid off early. Prepayment penalties that apply to selling a home and to a refinance are called "hard penalties". Ones that only apply to a refinancing are "soft penalties".
Do Second Mortgage Loans Have Prepayment Penalties?
Some second mortgage loans don't charge a prepayment penalty. But, a 3 year pre-payment penalty is common with fixed rate second mortgages. Many home equity lines of credit (HELOCs) advertise no prepayment penalties. But, they generally have what's known as "early termination fees". Similar to prepayment penalties, early termination fees are fees charged for paying off and closing a line of credit before the end of the loan term.
1-year, 2-year and 3-year early termination fees are common with HELOCs. Fees may be as low a few hundred dollars (typically anywhere from $350 to $750). Or, the lender may charge a percentage of your outstanding balance. Now, an increasing number of lenders are charging an early termination fee equal to the cost of establishing the line (the "closing" costs incurred by the lender that were waived when you opened the line). These fees can add up to thousands of dollars.
How Can I Avoid a Prepayment Penalty?
If you are shopping for a loan, find out if there is a loan option for which you qualify that does not carry a prepayment penalty. If not, see if you can buy out the prepayment penalty by paying a point or two on your loan. A point is 1% of the loan amount. If the best loan available to you carries a prepayment penalty, select the one with the shortest prepayment penalty term.
If you currently have a loan with a prepayment penalty, you probably won't be able to avoid paying it. However, if your move is due to your employer transferring you, contact your employer and let them know your loan has a prepayment penalty. Employers often have relocation packages that will pay for most or all of your moving and sale costs, which may also include the payment of prepayment penalties.
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