Up to 2% of balance
Prepayment penalties: what they are and when they apply
A prepayment penalty is a fee charged when you pay off a loan early. They're rare on modern residential mortgages but appear on some commercial loans, subprime products, and older mortgages. Hard penalties trigger on any early payoff (refinance, sale, lump sum); soft penalties trigger only on refinance. Federal law caps penalties at 2% of balance in the first 2 years and 1% in the third year.
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Try calculatorKey takeaways
04 · ideas- Hard prepayment penalties apply whether you sell, refinance, or pay cash
- Soft penalties apply only to refinancing, not to sale
- Qualified Mortgage loans have restricted prepayment penalty structures
- Commercial real estate loans often use yield maintenance provisions
A prepayment penalty is a fee charged when a borrower pays off all or a significant portion of a loan earlier than scheduled.
Why lenders charge them: Lenders earn revenue from interest over the loan term. When a borrower pays off early — particularly by refinancing to a competing lender — the original lender loses anticipated interest income. Prepayment penalties compensate for this.
Two types:- Hard prepayment penalty: Applies for any reason — sale, refinancing, or paying cash
- Soft prepayment penalty: Applies only to refinancing; not triggered by property sale