You may have heard the term prepayment penalty, usually referred to as a “prepay” or written as “pp” or “pre”. While prepays essentially lock you into your loan for a set number of months or years, they do usually come with a lower mortgage rate.
Electing to take a prepay on your loan can lower your interest rate by as much as half a percentage point, which can equal some serious savings over time. On a $500,000 loan, the interest-only payment at 6.5% is roughly $200 less than a rate of 7%. The only catch is that you can’t refinance or sell your home for a set amount of time.
Most prepays only last 1-3 years, but in the event that you need to refinance or sell prematurely, the prepayment penalty can be quite severe, typically 80% of six months interest. But if you’re happy with your home, your mortgage, and you feel comfortable to “lock yourself in” to the property for a few years, consider taking a prepay to lower your interest rate.
Just make sure the prepay is actually saving you money, and lowering your interest rate enough to actually make an impact. On loans such as a 30-year fixed mortgage, a prepay can be less significant than on an adjustable-rate mortgage. Research both options to see which makes the most sense.