Prepayment Penalty

· 2 min read
A prepayment penalty is a fee your lender charges if you pay off your mortgage too quickly — it exists because lenders lose money when…

A prepayment penalty is a fee your lender charges if you pay off your mortgage too quickly — it exists because lenders lose money when borrowers refinance or sell before the lender has collected enough interest to justify the loan. These penalties are rare on primary residence mortgages today, but they still pop up on investment property loans and some non-QM products.

How Prepayment Penalties Work

A typical prepayment penalty applies during the first 3-5 years of the loan. If you pay off more than 20% of the principal in a single year (through refinancing, selling, or extra payments), the penalty kicks in. The fee is usually 2-3% of the remaining balance or a set number of months’ interest.

The Dodd-Frank Act banned prepayment penalties on Qualified Mortgages originated after January 2014. Since most conventional, FHA, and VA loans are QMs, this rule protects the majority of borrowers.

Dollar Example

You have a $350,000 non-QM loan with a 3% prepayment penalty in the first three years. You decide to refinance after 18 months when your balance is $340,000. The penalty: $10,200. That could wipe out years of savings from a lower rate. You’d need to run the math carefully before pulling the trigger.

Watch Out

Always check for prepayment penalty language in your mortgage note before signing. It’s usually in a section titled “Prepayment” or “Early Payoff.” If you’re getting a non-QM or investment property loan, ask the lender directly: “Is there a prepayment penalty, and for how long?”

Some lenders offer lower rates in exchange for accepting a prepayment penalty. If you’re certain you’ll keep the loan for 5+ years, this tradeoff might make sense. But if there’s any chance you’ll sell or refinance sooner, avoid it. Compare your options with our loan comparison tool.

Frequently Asked Questions

Do prepayment penalties apply to extra monthly payments?

Usually not. Most prepayment penalties only trigger when you pay off the entire loan or a large portion in a single year. Making an extra $200/month toward principal is almost never penalized. But read your specific loan documents — the threshold varies. Use our mortgage calculator to see how extra payments affect your payoff timeline.