Mortgage prepayment penalties
June 8, 2004 4:51 PM   Subscribe

MortgageFilter: Does anyone have any experience with prepayment penalties for a variable rate mortgage? Our mortgage broker is strongly recommending a mortgage with a 10% payment limit per year, but I've heard rumors that it can turn out to be a bad thing. Any advice appreciated.
posted by gokart4xmas to Home & Garden (10 answers total)
I thought prepayment penalties were illegal, but perhaps I am wrong. Perhaps that was just a state law I seem to remember. In any event, I would inquire and research.

Prepayment penalties on a variable rate mortgage seem like an incredibly bad thing to me. What if you move and sell the dwelling? You will be paying off the mortgage and incurring the prepayment penalties.

At today's low rates, who in their right mind would take out a variable rate mortgage, which essentially ensures that your rate will rise, unless they are planning to move in just a few years. If you are planning to move - remember the prepayment penalties?
posted by caddis at 5:36 PM on June 8, 2004

It is a bad thing. Do not take a mortgage that has a prepayment penalty.
posted by languagehat at 5:49 PM on June 8, 2004

Caddis, it depends on the state. There are many predatory lending laws in many states and it can get rather complicated. It's not necessarily a bad thing but in high-risk lending the lender believes he has to take a burden of the risk in the form of fees or penalties.

I would assume that you'd not prepay until you want to sell, and effectively it's a selling fee... which I would calculate into the total cost of ownership.

I have no idea the usual amounts of the penalty and I'd look closely at it. If you can take a higher interest rate over the variable interest rate, I'd do that. I'd include the payment penalty (fee) as part of the interest rate, and then mess around with the number. See what the best deal is.

On Preview: Ok it's not a good thing, but if you have bad credit history or a multitude of things it might be the cheapest solution. Assume you have to pay it and figure out the best deal from there. I have no experience in turning bad credit into good credit, so if you can somehow do that I'd do that and wait till you can get a better mortgage.
posted by geoff. at 6:03 PM on June 8, 2004

Response by poster: Sorry, let me clarify. First of all, we have excellent credit, so that's not an issue. We can pretty much take our pick of mortgages. This one is locked in at 5.99% for three years, after which we'd either move or refinance. There is no penalty for selling the house before three years, we just can't refinance or pay off more than 10% above our monthly payments in a year.
posted by gokart4xmas at 6:22 PM on June 8, 2004

There are two kinds of prepayment: Overpayment on the mortgage principal -- which some particularly affluent folks can afford to do -- and the retirement of the loan, such as from a sale. If you're planning to overpay, a prepayment limit will be an annoyance. If you're planning to sell the home at any time during the life of the loan I have only one kind of advice: RUN!

You're likely to be better off with a loan at a slightly higher rate than with a prepayment penalty.

My mortgage broker has advised me to never accept a loan of any kind with prepayment restrictions.
posted by majick at 6:25 PM on June 8, 2004

Sounds like it's just there to try to prevent doing a refi. Chances are that the broker is getting some sort of kickback to push you towards that kind of loan. I think that it's unlikely that rates will go down much in the next few years, but I'd still pass on it myself.

If your credit is good, you should be able to find a comparable loan without this kind of limitation.
posted by freshgroundpepper at 6:27 PM on June 8, 2004

I recommend strongly against it, unless your mortgage is freakishly short-term (less than 5 years, for example).

Don't do it.
posted by aramaic at 6:28 PM on June 8, 2004

I'm lead to understand that variable rate mortgages have, over the past umptydozen years, proven to cost less than fixed-rate mortgages, even during times of high inflation.
posted by five fresh fish at 6:32 PM on June 8, 2004

I've refinanced my mortgage each year for the last three years, no penalties, no closing costs, and each time save nearly $100 per month. Wells Fargo may not be the best thing since sliced cheese but they're doing well by me.
posted by billsaysthis at 8:29 PM on June 8, 2004

When refinancing there is actually third variable in addition to interest rate and monthly payment -- the term/ length of the loan.

Many people do a refi over and over again and thus continue to owe money 30 years into the future eternally.

Sometimes one ends up with higher payment after refi. I refinanced from 30 years to 15 years, lowered interest rate by 1.5% and ended up paying $150 more/ month. But I'll save about a gazillion dollars in interest over the life of the loan.
posted by zeikka at 3:13 PM on June 9, 2004

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