What It Is

A prepayment penalty is a fee that the lender charges if you pay off a significant portion of your loan balance within a certain period (typically the first 3-5 years). The penalty is usually a percentage of the remaining balance (1-2%) or a set number of months of interest. It is designed to protect the lender's expected interest income.

Which Loans Have Them

Prepayment penalties are rare on standard mortgage products. You will typically find them on:

• Non-QM loans — Non-qualified mortgage products that cater to borrowers with unique situations
• Portfolio loans — Loans that the lender keeps on their books instead of selling to Fannie Mae or Freddie Mac
• Some subprime or non-traditional loans — These are less common now than before 2008
• Some investment property loans — Rare, but check the terms

Which Loans Don't

• Conventional loans — Fannie Mae and Freddie Mac prohibit prepayment penalties
• FHA loans — No prepayment penalties allowed
• VA loans — No prepayment penalties allowed
• USDA loans — No prepayment penalties allowed

How to Check

First, ask your lender directly. Second, read your Loan Estimate and Closing Disclosure. These documents will clearly state whether a prepayment penalty exists. Third, read your promissory note. If the loan has a prepayment penalty, it will be spelled out in the note.

When It Matters

A prepayment penalty matters if you plan to sell your home within the first few years, refinance to a lower rate, or make extra payments to pay off the loan early. If you have a prepayment penalty, you could face a significant fee when you sell or refinance.

Consumer Protections

The Dodd-Frank Act created significant restrictions on prepayment penalties. For most borrowers, prepayment penalties are prohibited or severely limited. The law also requires lenders to offer you a loan option without a prepayment penalty. If you are offered a loan with a prepayment penalty, the lender must also offer one without it.