Many home buyers are confused about the prepayment penalties that some mortgage lenders attach to their loans. It is important for home buyers to educate themselves about what these penalties are and how they may be affected by them. In many cases the prepayment penalty will have no effect, while in other situations there may be a significant impact.

In its simplest terms, a mortgage prepayment penalty is an obligation written into the loan documents that states that a penalty will be assessed if the entire loan, or sometimes part of the loan, is paid off before a certain date.

This prepayment penalty is often used to protect lenders from the risk of an early repayment of principal, and in some cases the borrower is rewarded for the prepayment penalty with a lower interest rate. It is important therefore for home buyers to carefully assess the impact of the lower interest rate and to determine if the difference in rate makes up for the prepayment penalty.

For those homeowners who plan to remain in the property for the long term, the answer to that question may be yes, since the amount of interest saved may more than make up for any potential prepayment penalty. This is doubly true if the homeowner does not plan to pay down the mortgage prior to the agreed upon date. For those homeowners, the benefits of the lower interest rate will likely far exceed any potential risk posed by the existence of the prepayment penalty.

It is also important for the home buyer to understand that there are in fact two different kinds of prepayment penalties, each with its own unique rules and characteristics. The first kind of prepayment penalty is the hard prepayment penalty. With this type of penalty, the home cannot be sold or refinanced within the specified period. A soft prepayment penalty, on the other hand, applies only in the case of a refinancing. The home can be sold within the penalty period but it cannot be refinanced.

After you have determined which type of prepayment penalty is applicable to the mortgage you are considering, it is important to know the amount of the penalty. The amount of the prepayment penalty will vary from loan to loan, but a typical penalty is for six months of interest. It is important for the home buyer to carefully assess the impact of this penalty in order to properly compare the various mortgage offers he or she has received. Through a thorough understanding of the prepayment penalty the home buyer will be in a better position to properly assess the offers and choose the one that represents the best fit.