What It Means
A prepayment penalty is a fee a lender can charge when you pay off a loan early, usually by selling the home, refinancingRefinancingReplacing a loan you already have with a new one, usually to get a lower rate, a different term or a different payment. See more or paying the balance in one go. On home loans, federal rules under Regulation Z allow one only on certain qualified mortgagesMortgageA loan used to buy or refinance a home, secured by the home itself and repaid in monthly installments over a set term. See more and cap how large it can be and how long it can last. Whether any loan carries one is set out in its paperwork, and on a mortgage the Loan Estimate and Closing Disclosure both say so.
Try It: Check the Most a Mortgage Penalty Could Be
For a mortgage covered by Regulation Z's rules. Enter the balance and when you'd pay it off.
A covered mortgage outside that group can't carry a prepayment penalty at all.
After the third year, no prepayment penalty is allowed.
That's a ceiling. Your loan's own penalty, if it has one, is on your Closing Disclosure.
How People Say It
- "Is there a penalty if we sell in two years?"
- "Check the Loan Estimate for a prepayment penalty before you sign."
- "We waited until year four to refinance so there'd be no fee."
The Breakdown
Worked example. The most a prepayment penalty could be on a $300,000 balance, for a mortgage allowed to carry one under Regulation Z:
| When you pay it off | Federal cap | Most it could be |
|---|---|---|
| First or second year after closing | 2% of the balance | $6,000 |
| Third year | 1% of the balance | $3,000 |
| After the third year | None allowed | $0 |
What the result means. The cap shrinks as the loan ages and ends after three years, so the timing of a sale or refinance can change what you owe. These are upper limits: a given loan may carry a smaller penalty or none, and most covered mortgages can't have one at all. When you're weighing a refinance, add any penalty to the new loan's closing costsClosing costsThe fees and upfront charges you pay to finalize a mortgage, apart from the down payment, itemized on your Loan Estimate and Closing Disclosure. See more before working out the break-even point.
Where to look. Your Loan Estimate and Closing Disclosure each answer "Prepayment Penalty" yes or no, and when the answer is yes, they show the maximum amount and how long it can apply.
Good to Know
Regulation Z, at 12 CFR 1026.43(g), lets a covered mortgage carry a prepayment penalty only if it's a qualified mortgage with a fixed or step rate that isn't higher-priced, and the lender must also have offered you a loan without one. Even then, it can't exceed 2% of the outstanding balance in the first two years or 1% in the third, and none is allowed after that. The Consumer Financial Protection Bureau adds that a prepayment penalty doesn't normally apply to small extra paymentsExtra paymentMoney paid toward a loan on top of the required payment, usually to lower the principal sooner, which cuts the interest and can shorten the loan. See more toward principal, though it's worth confirming with your lender. For car loansCar loanAn installment loan used to buy a vehicle, repaid in monthly payments over a set term, with the vehicle as collateral. See more and personal loansPersonal loanAn installment loan, usually unsecured, that a bank, credit union or online lender pays out as a lump sum you can use for almost any personal purpose. See more, check the loan agreement for any penalty before you sign.
FAQ
How do I know if my mortgage has a prepayment penalty?
Look at the Loan TermsLoan termHow long you have to repay a loan, usually stated in months for a car loan and in years for a mortgage. See more section of your Loan Estimate or Closing Disclosure, which answers "Prepayment Penalty" yes or no. If it's yes, the form shows the maximum amount and the period it covers.
Does making extra payments trigger a prepayment penalty?
Usually not for small ones. The CFPB says a prepayment penalty doesn't normally apply to small extra principal payments, and suggests double-checkingChecking accountA bank or credit union account for everyday money going in and out, used by debit card, checks, transfers and direct deposit. See more with your lender.
How long can a prepayment penalty last on a mortgage?
For mortgages covered by Regulation Z's ability-to-repay rules, no more than three years after closing, with a cap of 2% of the balance in the first two years and 1% in the third.
Do It in Buhata
Vault, Countdown
With Plus, save your Closing Disclosure in Vault, and if it lists a prepayment penalty, add the date it ends to Countdown before you plan a sale or refinance.
Open BuhataRelated Terms and Categories
- Mortgage
A loan used to buy or refinance a home, secured by the home itself and repaid in monthly installments over a set term.
- Refinancing
Replacing a loan you already have with a new one, usually to get a lower rate, a different term or a different payment.
- Extra payment
Money paid toward a loan on top of the required payment, usually to lower the principal sooner, which cuts the interest and can shorten the loan.
- Closing costs
The fees and upfront charges you pay to finalize a mortgage, apart from the down payment, itemized on your Loan Estimate and Closing Disclosure.
- Amortization
Paying off a loan through regular scheduled payments, each split between interest and principal, until the balance reaches zero at the end of the term.
- Personal loan
An installment loan, usually unsecured, that a bank, credit union or online lender pays out as a lump sum you can use for almost any personal purpose.
Sources
Consumer Financial Protection Bureau, "What is a prepayment penalty?"; CFPB, Regulation Z "ยง 1026.43 Minimum standards for transactions secured by a dwelling"; eCFR, 12 CFR 1026.43; CFPB, "Closing disclosure explainer"; CFPB, "Guide to the Loan Estimate and Closing Disclosure forms"
- www.consumerfinance.gov/ask-cfpb/what-is-a-prepayment-penalty-en-1957
- www.consumerfinance.gov/rules-policy/regulations/1026/43
- www.ecfr.gov/current/title-12/chapter-X/part-1026/subpart-E/section-1026.43
- www.consumerfinance.gov/owning-a-home/closing-disclosure
- files.consumerfinance.gov/f/documents/201707_cfpb_KBYO_Guide-Loan-Estimate-and-Closing-Disclosure-forms.pdf
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