If you want to pay off your mortgage, you just send in a check for the remaining principal amount and that takes care of that, right? Not necessarily. You may have an additional fee called a prepayment penalty.
This fee may be as high as two percent. On a $200,000 mortgage, that’s an extra $4,000 which is a hefty chunk of cash for retiring a loan.
If you’re a veteran with a VA loan, there’s good news. VA loans don’t have prepayment penalties.
Benefits of Paying off a VA Loan Early
Even if there’s no penalty, why pay off your loan early? If your monthly payment is comfortable, why not leave it at that?
The reason: to cut the interest you’ll pay. When you signed up for a 30-year, $200,000 loan, you committed to also pay six figures in interest, assuming you make only your regular monthly payments.
You can’t pay less principal, but you can do a lot to pay less interest. You can
- Make one extra payment every year
- Increase every monthly payment by a dollar amount or percentage
- Apply “extra money,” such as tax refunds and bonuses, to your mortgage
If you make just one extra payment every year, you knock about 2 ½ years off your mortgage. That’s tens of thousands saved. If you trade up to a larger home, you can apply extra thousands toward your next down payment.
Loans that Charge a Prepayment Penalty Fee
Housing prices rise and fall, mortgage rates fluctuate, but the prepayment penalty fee stays with us. While there’s no prepayment penalty allowed for VA loans, some other loans charge a fee to pay off early.
Conventional Loans
Lenders are permitted to impose a prepayment fee on conventional loans, and many do. There’s a limit on these under the Dodd-Frank Act. It’s 2 percent in the first two years and 3 percent in the third year. No prepayment penalty is allowed after the third year.
FHA Loans
FHA loans don’t have the fees that conventional loans do, but they charge for interest left in the installment period. For example, if your loan is due on the first, and you pay the mortgage off on the prior 15th, you’ll be charged an extra half month’s interest. However, for most loans this is at most a few hundred dollars, not thousands.
Saving on Interest
One way to save on interest is to pay your mortgage early. Another way is to commit to less interest in the first place. You do this by making a down payment.
VA loans don’t require a down payment, but that doesn’t mean you can’t make one. If you manage to put, say, $10,000 down, you knock off close to $7,000 in interest over the life of the loan at today’s rates.
The more put down, the more you save. If you sell, the more you take out.
Benefits of Paying a Prepayment Penalty
It might seem that you never want to pay a prepayment penalty. Why give that money? However, there are occasions when it makes sense. If you’re able to refinance and get a lower rate, and you plan to stay in your home for many years, you can save enough over the life of the mortgage to more than make up for the penalty.
Final Thoughts
- Some mortgages have prepayment penalties as high as 2 percent.
- VA loans have no prepayment penalties.
- You can save interest expense by paying your loan more quickly or by making a larger down payment.
- A prepayment penalty may be acceptable if you refinance to a lower rate and keep your home a long time.
Still have questions? Contact Mid America Mortgage for answers or for help on your next new mortgage or refinance.
