Glossary

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Prepayment

Definition

Prepayment is aying some or all of a loan ahead of schedule.

Prepayment Explained

Most mortgage loan programs allow prepayment. Prepaying a mortgage can reduce the amount of mortgage interest paid over the life of the loan and can eliminate the loan faster.

Under recent mortgage reforms, a prepayment penalty is allowed only if all of the following are true.

  • The loan must have a fixed rate.
  • It must be classified as a “qualified mortgage,” a “plain vanilla mortgage without risky features.
  • It cannot be classified as a “higher-priced” mortgage.

Accelerated Payments

One form of prepayment is to make accelerated payments on your mortgage.  In other words, pay more than the amount due each month, earmarking the extra amount for the principal. Some lenders will allow you to pay half your monthly mortgage amount every two weeks. Over time, the prepayments add up because 11 of the 12 months have more than 28 days, or two, two-week payment cycles.

Refinancing

Another form of prepayment is refinancing, in which you get a new loan to pay off the old loan. You can refinance for a number of reasons, among them to lower your monthly payments or to pay your loan off more quickly.

Prepayment Penalties

There are two kinds of prepayment penalties that apply if a loan with a penalty is paid off in its first few years. There are “hard” prepayment penalties, which are assessed if the loan is prepaid for any reason, and “soft” prepayment penalties, which only apply if the loan is prepaid with a mortgage refinance. If the home is sold, no penalty applies.

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