Before you apply for a mortgage, you would be packed up with things to do. Right from consulting the best mortgage broker to exploring the best rates for financing, you would cherish this overwhelming time. Now that you have purchased your home, it’s time to re-think and try to cut down your interest rate.
You may end up with penalties during the mortgage renewal process if you are not careful enough. Of course, you may want to close your mortgage earlier or switch lenders, offering a better rate of interest. However, it pays to know about different aspects of mortgage renewal penalties. You can click here to explore different mortgage refinancing options.
What Are Your Early Renewal Options?
Certain mortgages allow you an option for early renewal. This option proves handy when the rates of interest start escalating. Since you are already locked into the deal, it won’t be maturing for the subsequent months. The lender might also allow the homeowner to lock the interest rate for a particular amount before the renewal. Therefore, when there is a change in interest rate between that time and the maturity date, you would have to pay interest at the locked-in rate.
At the time of renewal, certain mortgages allow the borrowers to make a prepayment. Here, you need to make a lump-sum payment for the principal to bring down the interest rate. However, you should check out the terms and conditions of the loan, as this might attract an early renewal penalty.
What Is A Prepayment Penalty? Why Do Lenders Charge This Penalty?
A prepayment penalty of a mortgage is also referred to as an early payoff penalty. This is the fee that the lender would charge you if you decide to pay the balance principal earlier than the scheduled date. This amount is generally a certain percentage of the unpaid principal.
As a borrower, you should know that prepayment penalties are disadvantageous. In order to lower the interest for the subsequent months, you may decide to pay off a lump-sum amount against the principal. This would also allow you to close the mortgage faster. The lower your unpaid principal amount, the lower would be the interest you pay.
However, lenders charge the prepayment penalty as they would make less income if a borrower pays off the principal amount earlier. When you try to pay off a part of the principal amount, you end up shelling out the prepayment penalty. This often discourages borrowers from paying off the amount early.
Prepayment Penalty During Refinancing
In case you want to go for refinancing, you would have to clear the current loan you are liable for. In this case, as well, you need to shell out a certain amount as a penalty. The creditors impose these penalties so that you think twice before switching to the lower interest rates or refinance the mortgage. It means that you won’t be able to make the best use of your home equity to fulfill your financial goals.
If you want to consolidate loans, pay off credit card loans, or make some home improvements, you may go for a home equity loan. In case you decide to go ahead with it, you would have to pay the penalty for pre-closure.
Costs Associated With Prepayment Penalties
In case you decide to repay the outstanding principal, the rates of prepayment penalties start from approximately 2% of the remaining amount. In some loans, the penalties might be higher. However, most lenders fix this rate between 2% to 4%. Each subsequent year, the penalties keep declining until the loan is cleared off. Lenders primarily assess the outstanding principal amount when a borrower makes the prepayment.
Under specific prepayment clauses, borrowers are allowed to make payment for a particular percentage of the outstanding amount. Typically, this is around 20% of the balance principal, where the lenders won’t charge any prepayment penalty. Therefore, if you are keen to make some additional payments during the initial years of the loan, you can capitalize on this provision.
Again, some creditors have a different mechanism for calculating these penalties. Certain lenders charge a fee equal to the interest amount you would be paying for a certain number of months. However, you should ensure that these norms are mentioned in your loan agreement.
How Can You Avoid a Prepayment Penalty?
Here are certain tactics that would help you avoid shelling out the prepayment penalty.
- Firstly, check out some alternative lenders. These are generally non-bank lenders who operate online. They specialize in providing subprime loans, where you enjoy more flexibility.
- Do not go for refinancing the mortgage frequently. This would indicate to the lender that you are going to switch to a different creditor as soon as there is a drop in the interest rate.
- Look out for a co-applicant for the mortgage so that you can pay more during the down payment. In return, you would enjoy a longer term to pay off the loan. The prepayment fee can also be waived under certain conditions.
- Another way to ditch prepayment penalties is to wait out the phase till which you need to shell out these amounts. Once this period is over, you can go for refinancing. Alternatively, you can make additional payments while remaining under the limit that the lender permits you. This won’t trigger penalties for closing the loan early.
- If you want to utilize a windfall gain to prepay your obligations, do so in parts and not all at once.
Pre-closing your mortgage or refinancing them brings you several benefits. While you shell out a lower rate of interest, you can also get rid of the liability faster. However, you may also end up paying more as a result of prepayment penalties. Therefore, it is advisable to seek professional guidance if you want to refinance your mortgage or close it off earlier. With the experts showing you the right way, you can ease up your finances significantly.