Pre-payment penalties can be good and not
so good.
In short, a pre-payment penalty is designed to
assure the lender that you will have the loan for a minimum period of time.
The penalty will ensure that you don't break your agreement with the
Lender. Some penalties are 'soft' and others are 'hard'.
A soft pre-payment penalty allows you to payoff
your loan at any time, but will still charge you a penalty fee if you
choose to refinance within a stated period of time, generally 3-5 years.
Many times accepting a soft pre-payment penalty will be in exchange for a
reduced rate or a reduced fee.
A hard pre-payment penalty will not allow
deviation from the original terms stating the time that you must
maintain/retain the original the loan. Either paying off the loan or
refinancing the loan will trigger the penalty. Many lenders will
charge a penalty equal to 6 months interest on 80% of the loan balance.
If your loan is relatively new, this penalty can be quite costly.
Warning! Beware of pre-payment penalties that
are greater in length than the terms OR an ARM. For Example; a 2-year ARM
with a 3 year prepayment penalty. If rates are up at the end of your two
year ARMs first adjustment, you are stuck with an increase instead of
being able to refinance to another loan at the two year point. A note on
pre-payments penalties, they generally appear on sub-prime loans.
