Often, the VA loan benefits that many VA-eligible borrowers notice first are zero down, 100% refinancing and no private mortgage insurance. But, another benefit that is sometimes overlooked is "no penalty for prepayment" which is a standard feature with veterans' mortgages. This benefit has saved VA borrowers significant amounts of money.
A prepayment penalty is a fee that a borrower must pay if a mortgage is satisfied or partially paid early, before the complete duration of the loan is up or before another specific designated period of time. A Prepayment Penalty Mortgage (PPM) is a loan with prepayment penalty terms. Conforming, low interest rate loans usually have no prepayment penalties, while creative, non-conforming loans often do.
Prepayment might be considered to have occurred if a borrower pays all or a portion of the loan early. A borrower might pay back all or part of the principal of the loan within the first three years - the time during which most of the mortgage payments are applied toward interest.
Another common prepayment circumstance might be when a loan is refinanced. Even though the borrower is refinancing the same property, the PPM is being paid off with the refinance loan and technically that can be considered prepayment. In many cases, including extra toward principal along with a monthly mortgage payment can even be considered prepayment. It goes without saying that most lenders who make PPMs consider prepayment to have occurred when a house is sold and a loan is paid off.
A borrower should weigh the pros and cons of PPMs against costs and benefits of loans that do not contain prepayment penalties. Of course PPMs would not exist if they didn't have their benefits such as lower lending fees and smaller interest rates. But, borrowers should carefully consider the terms of PPMs and the potential cost associated with making a prepayment before signing such a loan. Borrowers who are unaware of prepayment penalty terms could end up paying thousands extra.
It's required by law that lenders disclose prepayment penalty terms. And, borrowers have the choice to accept or reject a loan based on its prepayment penalty terms. Regardless whether a loan has prepayment penalties or not, Borrowers should always read contracts carefully before signing them.
It's good to ask the lender to point out the section in the loan document that discusses prepayment penalty. If a prepayment penalty is present in the contract, the terms should be read carefully to be certain they are something the borrower can live with. Nobody likes unpleasant surprises after signing a loan.
Typically prepayment penalties are 80% of 6 months interest - in other words thousands of dollars. You never know when life is going to throw a curve ball that could force a PPM borrower to prepay a mortgage and result in a substantial and tough financial strike.
The first quarter of 2009 sees interest rates at an all-time low, and many are refinancing to save money. A PPM can hamper refinance capabilities should an opportunity to get a lower rate arise.
A borrower might like or need to get cash out of equity in order to make home improvements or pay debts. This is when a borrower might wish he or she had never agreed to that PPM. In the situation of a cash-out refinance, PPMs can put a choke hold on a borrower, because he or she can't get out of the loan due to the prepayment penalty.
Lower lending fees and interest rates associated with PPMs can be alluring if borrowers are sure they will keep their homes for a long time, make their minimum monthly payments, not seek cash out of equity, and are happy with the interest rate they've locked into. However, if a borrower is uncertain of any of these factors, then a PPM can be a risky and costly gamble.
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Alternately, veterans' mortgages never have a prepayment penalty. A VA borrower can sell at any time, and pay off the loan at any time, without paying a penalty. It's the advice of many financial gurus to pay a little extra each month toward loan principal. This simple practice can significantly reduce the duration and the total cost of a mortgage. A VA loan leaves borrowers "free" to pay extra each month and in doing so, can reduce the total cost of their loans without penalty. VA borrowers are at liberty to refinance for a lower rate and get cash out of equity, too, without penalties.
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