No down payment, up to 100% financing, no PMI — these are probably the most popular of all the VA loan benefits. But, another benefit to getting a veteran’s mortgage is the “no penalty for prepayment” feature is standard with every VA loan.  This can save borrowers significant amounts of money.

 

Prepayment Penalty Mortgages or PPMs are loans that require borrowers to pay a fee if the loan is paid in full before the end of the loan’s complete duration or within a specific designated time period. Typically, conforming loans with low interest rates do not have prepayment penalties. But, non-conforming loans with creative terms are often the ones with prepayment penalties.

 

Sometimes, a borrower is only penalized if the loan is paid early, such as when the borrower pays back all or part of the principal of the loan within the first three years.  This is the period during which most of the payments are applied toward interest and the PPM lender stands to lose the most.  One prepayment scenario might be when a loan is refinanced, and one loan is paid off by another. 

 

With other PPMs, a prepayment can even be triggered by paying extra toward principal in addition to a monthly payment.  Many lenders who make PPMs also consider prepayment to have occurred when a house is sold and a loan is paid off. 

 

Borrowers beware: if offered a loan with a prepayment penalty be sure to carefully consider the pros and cons before signing.  Certainly, there can be benefits to PPMs such as lower lending fees and smaller interest rates.  But, borrowers just need to fully understand all the terms and conditions with prepayment penalties and the cost associated with making a prepayment before agreeing to the loan.  PPM terms could cost an unsuspecting borrower thousands of dollars.

 

Legally, prepayment penalty terms must be disclosed by the lender.  It’s a borrower’s right to accept or reject a loan that includes a prepayment penalty.  Borrowers should always read loan documents carefully before signing to be sure that prepayment terms, if any, are as they expect them. 

 

On the side of caution, a borrower might ask the lender to point out where it says “no prepayment penalty” in the mortgage contract.  If there is a prepayment penalty, the provision should be read carefully to be sure the penalty terms are something the borrower feels comfortable with.  Seeing prepayment penalty terms in print before signing may prevent any unwelcome surprises later.

 

Typically, prepayment penalties are 80% of 6 months interest.  Translate to dollars, we are talking thousands.  This can be a most devastating blow to someone who is not prepared.

 

Something else one needs to know is that a PPM can hinder a borrower’s ability to refinance should a lower rate become available.  And, we all know interest rates are falling at record pace due to the 2008 recession and the Fed attempt to bounce the economy back.  What seemed like a good rate on a PPM at the time the loan was acquired might not seem so good when interest rates reach historic lows.

 

Another point to consider is getting cash out of equity.  If a PPM borrowers wants, or needs, to get cash out of the equity to make home improvements or pay down debts, he or she might wish he or she had never agreed to that prepayment penalty.   PPMs can tie a borrower’s hands and he or she is stuck with the loan due to the prepayment penalty terms. 

 

Lower lending fees and interest rates often found with PPMs can be a benefit if borrowers are sure they will stay in the house for a long time, make only their scheduled monthly payments that do not include extra payments on principal, and do not plan to get cash-out refinancing or future lower rates.  If a borrower is uncertain of any of these factors, then a PPM can be risky and costly. 

 

Remember, VA mortgages never have prepayment penalties.  VA borrowers can sell their homes at any time and pay off mortgages at any time without incurring prepayment penalties.  It’s the advice of many financial experts that paying just $50 per month extra toward mortgage principal can significantly reduce the duration and the total cost of a mortgage.  VA loan borrowers are “free” to pay more toward principal each month and can reduce the total cost of their loans without penalty. VA borrowers are also free to refinance for a lower rate and get cash out of equity, too, without taking a hit.