What is a prepayment penalty? It’s a fee that some lenders charge when a borrower pays off a mortgage early, in whole or in part.
Not every mortgage has one. When a loan does carry the fee, the CFPB’s consumer answer says the borrower agreed to it at the closing on the home. So closing is the time to ask.
The practical question for a borrower is narrower. Does your own loan have one? Find that out after closing, and you’ve already signed the terms. Your loan officer can answer that question before then.
What Is a Prepayment Penalty?
On the CFPB’s Ask CFPB page, a prepayment penalty is a fee a lender may charge when a borrower pays off a mortgage early, in whole or in part. Not every mortgage carries one. That definition comes from the CFPB’s answer on prepayment penalties, which is general consumer information.
The consumer answer puts it this way: “A prepayment penalty is a fee that some lenders charge if you pay off all or part of your mortgage early.” It also says: “Not all mortgages have a prepayment penalty.”
Who agrees to the fee? The borrower does, at closing, if the loan has one. The page says that if you have one, “you would have agreed to this when you closed on your home.” So the loan terms deserve a careful read before closing day, and a loan officer can say how all of this applies to a specific loan.
When Does a Prepayment Penalty Apply?
The CFPB’s answer ties the fee to paying off the whole balance. Selling the home or refinancing the mortgage are its examples. It applies only within a set number of years after closing. Paying a large amount at once can bring it into play as well.
The consumer answer says a penalty “only applies if you pay off the entire mortgage balance”, and then only “within a specific number of years”. Its examples of paying off that balance are selling the home and refinancing the mortgage.
There’s one more case on the page. It says “a prepayment penalty could apply if you pay off a large amount of your mortgage all at once”. That sentence matters if a lump sum against the principal is part of your plan.
A borrower weighing a refinance can also read why a refinance has to earn back its closing costs.
Do Extra Payments Trigger a Prepayment Penalty?
Paying extra principal a bit at a time doesn’t normally trigger the fee, according to the CFPB’s consumer answer. The page doesn’t stop there, though. It tells readers to double check with the lender. Your own loan terms matter here, so that check is worth making before you send extra money.
In the page’s words: “Prepayment penalties do not normally apply if you pay extra principal on your mortgage in small chunks at a time”. Normally is the page’s own word. That’s why the question still belongs to your lender, loan by loan.
A home equity loan is a different loan from your mortgage, so a borrower weighing an early payoff on one can read about paying off a home equity loan early.
Is a Prepayment Penalty Allowed on Every Mortgage?
Not on every loan. Under the CFPB’s text of Regulation Z section 1026.43, a covered transaction can’t include the penalty unless specific conditions are met first. A covered transaction is the regulation’s name for the loans the rule covers. So the fee isn’t available on every covered loan.
The regulation’s lead-in reads: “A covered transaction must not include a prepayment penalty unless”, and then it lists conditions:
- the penalty is otherwise permitted by law
- the loan “Has an annual percentage rate that cannot increase after consummation”
- the loan is a qualified mortgage under the regulation and “Is not a higher-priced mortgage loan”
These are conditions for covered transactions. In the regulation’s language, creditor means the lender, and consummation is the point at which you become contractually obligated on the loan, which for many buyers is the closing. Whether a given loan is covered, and whether it carries a penalty, is a question a loan officer can answer.
How Long and How Big Can a Prepayment Penalty Be?
For the loans the regulation covers, it caps both. The fee can’t apply after three years from the closing of the loan. Its size is set as a percentage of the balance being paid off, and the cap drops in the third year. Both limits come from the regulation itself.
On length, the rule says a penalty “Must not apply after the three-year period following consummation”. On size, it says a penalty “Must not exceed the following percentages of the amount of the outstanding loan balance prepaid”, and two percentages follow.
Those percentages are “2 percent, if incurred during the first two years following consummation” and “1 percent, if incurred during the third year following consummation”. What that comes to in dollars depends on how much of the balance gets paid off, and a loan officer can say how a particular loan’s penalty would be figured. Those are the regulation’s limits for covered transactions. The consumer answer’s own wording is “within a specific number of years”, and the loan terms are where a borrower’s own answer lives.
Can You Ask for a Loan Without a Prepayment Penalty?
Yes, and the rule anticipates the question. Under the regulation, a lender offering a covered loan with the fee must also offer a covered loan without it. The CFPB’s tip for borrowers is to ask for a quote on a similar loan without one, then compare the total costs of each.
The regulation’s words are that a creditor must not offer such a loan “unless the creditor also offers the consumer an alternative covered transaction without a prepayment penalty”. Creditor, in that sentence, means the lender. The alternative has to meet the regulation’s own conditions, and a loan officer can explain those.
The consumer page’s tip is direct: “Ask your lender for a quote for a similar loan without a prepayment penalty so you can compare total costs”. And if a loan you’re considering has one, the page says to “make sure to read the fine print carefully”.
Where Your Own Loan Fits In
A rule describes what’s allowed. It doesn’t tell you what’s in your paperwork. Whether a particular loan carries the fee depends on that loan, and the answer sits in the loan terms and with the lender. So bring questions instead of guesses.
Fellowship’s mortgage process page describes what its team looks at: “We holistically assess income, debt-to-income ratio, credit score, employment trajectory, and property type to determine eligibility.” It adds: “Each loan program has different sets of eligibility guidelines.”
Fellowship’s home purchase page puts it this way: “Depending on your circumstances, one home loan may be better than another.” That’s why questions about a prepayment penalty are worth talking through with a loan officer.
Frequently Asked Questions About a Prepayment Penalty
What is a prepayment penalty?
The CFPB’s consumer answer describes it as a fee that some lenders charge if a borrower pays off all or part of a mortgage early. Not all mortgages have one. If a loan does, the borrower agreed to it at the closing on the home.
Do all mortgages have a prepayment penalty?
No. The CFPB’s consumer answer says not all mortgages have one. The federal mortgage rule goes further for the loans it covers: a covered transaction can’t include the fee unless conditions are met, including an annual percentage rate that can’t increase after closing. Your loan officer can say what applies to your loan.
Does selling or refinancing trigger a prepayment penalty?
Selling the home and refinancing the mortgage are the CFPB’s examples of paying off the entire balance, which is when the fee applies, and only within a specific number of years after closing. Whether your own loan has one is a question for your loan officer.
Do small extra payments trigger a prepayment penalty?
The CFPB’s consumer answer says prepayment penalties do not normally apply when a borrower pays extra principal a bit at a time. Normally is the page’s own word, and the page tells readers to double check with the lender. Ask what your own loan terms say.
How long can a prepayment penalty last?
For the loans it covers, the federal mortgage rule says a penalty must not apply after the three-year period following the closing of the loan. The CFPB’s consumer answer speaks of a specific number of years. Your loan terms say what applies to your mortgage.
Will a lender offer a loan without a prepayment penalty?
The federal mortgage rule says a lender offering a covered loan with a penalty must also offer the borrower an alternative covered loan without one. The CFPB’s tip is to ask for a quote on a similar loan without a penalty so you can compare total costs before you decide.
Questions to Bring to Your Loan Officer
A prepayment penalty is simplest to plan around when you ask before closing. The answers sit in the loan terms and with your loan officer. So bring questions instead of guesses. These four are worth asking.
- Does my loan have a prepayment penalty?
- If it does, how long would it apply, and how would it be figured?
- What would a quote for a similar loan without one look like?
- Would paying extra, or paying the loan off early, trigger it?
When you’re ready, you can talk with a Fellowship loan officer about your loan.
