A prepayment penalty is penalty or charge to the borrower if the loan is paid off early.

A prepayment penalty can be anywhere from 1 to 5 years but normally it is 2 years.

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That means if you pay off your loan before 2 years are up, you owe the lender.

Prepayment Penalty Defined

The prepayment penalty is a percentage of the loan amount or it can be 6 months of interest. For example, you buy a home and get a loan with a 2 year prepayment penalty.

You decide to refinance your home 18 months after you bought it.

Since you have not had the loan the full 2 years, you owe 6 months interest according to your loan documents. The interest payment is $1,500.

That means you owe $9,000 in addition to the loan balance.

Your payoff for your new refinance will now include an additional $9,000 added to it for an early payoff charge.

Many people do not know they have a prepayment penalty even though during the closing there will be a document you sign with the terms of the prepayment penalty on it.

It is also disclosed on the Truth in Lending in the initial application.


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