You may have heard the term prepayment penalty, usually referred to as a “prepay” or even abbreviated 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.
So if you don’t have immediate plans to move or refinance, agreeing to one could actually keep your mortgage rate down.
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.
For example, the interest-only payment at 6.5% on a $500,000 loan is roughly $200 less per month than a rate of 7%. The only catch is that refinancing is out of the question, as is selling 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 your home unexpectedly, 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, the savings from a prepay can be less significant than on an adjustable-rate mortgage, for obvious reasons. Research both options to see which makes the most sense.