Ryan's Mortgage Blog:

Be aware of the prepayment penalty when receiving a loan. ALWAYS ask if your loan has a prepayment penalty BEFORE signing anything, if it does ask why and what the terms are. If you don't like it, do elsewhere. BUT, not all prepayment penalties are bad or unfair, and I'll explain why in a second. A prepayment penalty is just as it sounds, a penalty if you pay all, or a large portion of the loan (usually more than 20% at a time) off before a specified time. Not all loans have prepayment penalties, they are usually attached to loans that are adjustable (5 year ARM), subpar loans, and loans with special some kind of special offer (maybe one year at a certain low rate that turns into a fixed loan at a higher rate).

You also need to know the difference between a soft and a hard prepayment penalty. A soft means you can pay off the loan without a penalty if the house is sold, but cannot refinance without a penalty. A hard means you can't payoff the loan in anyway without a penalty. Usually the penalty is 6 months interest, and can be very costly. It is all a matter of numbers though if you currently have a prepay penalty and are thinking about selling or refinancing and paying the penalty. You just have to do the math, because there are scenarios (though probably rare) where paying the penalty could save you money within a year or two by refinancing. Or maybe you have a buyer desperate to buy your house and will pay to have your hard prepay penalty paid off.

Basically a prepay is the lender saying we don't want you to refinance(or sell in cases of a 'hard' penalty) within a certain time frame. This can be a fair thing for them to do in some cases. If they offer you a teaser rate below current market rates, they are making a deal with you saying we will charge you "z" rate for now, and "y" rate later, but you have to promise(prepay penalty) to not refinance before "x" amount of years. They are saying we aren't making the money at first off of you as we are with our other clients, so we want to make sure you stay with us long enough to make money off of you. But that is what banks and all other businesses do, make money... so don't be shocked by this theory. Usually a prepay penalty lasts 1 - 3 years, and should not be longer than 5 years.

I personally would not accept a deal that has a "hard" prepayment penalty, but wouldn't mind getting a loan that carried a soft prepay for around 3 years as long as I get a good rate with the deal.

I wouldn't mind answering any questions for you regarding other lenders or brokers offers to you, or helping you compare deals. It only takes a second and I am always looking for some good Karma anyways and like to help people out.

Feel free to contact me at RBaker@PeregrineLending.com or 805-540-0866.