Not Texan approves of mortgage prepayment, but it can improve your finances if you do it right. Paying off your home loan early allows you to save a boatload of money on interest, accelerate the growth of your home equity, and have a house free and clear before reaching your retirement.
However, any mortgage broker in Lake Dallas, Krum, Little Elm, and Aubrey will tell you that prepayment usually comes with an expensive fee. A prepayment penalty is a defense mechanism a lender uses to minimize profit reduction and discourage a borrower from making outrageously large extra payments to shrink the principal balance.
Fortunately, there are ways to pay off a mortgage way before its maturity without any penalty.
Choose a Government-backed Loan
The most effective way to avoid a prepayment penalty is to apply for a mortgage that comes with none. FHA, USDA, and VA loans do not prohibit prepayment at any given time. In hopes of decreasing the burden of homeownership, the government encourages you to pay off any of the mortgages it backs as early as possible so that you can live in your house free and clear ASAP.
Determine Whether an Applicable Penalty Is Soft or Hard
When taking out a qualified mortgage, where a prepayment penalty can be legally charged, read the fine print to understand when it can kick in. In general, prepayment penalties are either soft or hard.
A soft penalty applies only when the repayment calendar is cut short due to a refinance. A hard penalty applies when prepayment was done via a refinance or a house sale.
The law says the penalty is capped at 2% of the outstanding principal balance when a mortgage is paid off within two years from the date it was consummated. The penalty goes down to 1% of the principal balance max when the mortgage is repaid in the third year.
Do Not Finish Repayment within Three Years
The government outlaws the imposition of a prepayment penalty after year three of the loan. In the eyes of the authorities, collecting interest payments for 36 months is fair enough for mortgage lenders. By the fourth year of your mortgage, you can pay your loan off at any point moving forward without any monetary punishment.
Know Your Boundaries
Paying your mortgage more than what you are supposed to per year is allowed. However, your lender can impose a yearly additional payment maximum. Usually, your further payment for one year should not go over 20% of the principal balance.
If you plan to make nominal extra payments, this rule might not be of great concern. But if you intend to pay in a lump sum, make sure to review your contract. It should spell out the maximum allowable extra payment you could earn over a specified period.
Not worrying about a prepayment penalty gives you the freedom to not just own your house completely sooner rather than later but also move and sell your property whenever you want. Mortgage rules can somewhat vary from lender to lender, so exercise due diligence when comparing home loans.