Information about reverse mortgages and pre-payment penalties.
A mortgage prepayment penalty is a clause written into a mortgage to discourage mortgage holders from refinancing or paying off their loan early.
Are there different forms of prepayment penalty clauses?
Yes, there are hard prepayment penalty clauses and soft prepayment penalty clauses. A hard penalty applies to both a loan refinance and an early payoff. Soft penalties only apply to early payoff. The type of penalty a mortgage has is stated in the prepayment clause.
Why do lenders add a prepayment penalty to their agreements?
Interest income is a mortgage lender’s main source of revenue. Most mortgage originators do not mind a few extra payments. When the borrower pays off more than 20% of the balance in 12 months then the lender’s future income is threatened. For example, a borrower pays off a 30 year mortgage within 10 years, 20 years of anticipated interest income have been diminished. The prepayment penalty makes refinance or prepayment of a recently issued mortgage more expensive and therefore less desirable and cost effective. Most prepayment penalties will decrease or disappear after a certain number of years specified in the prepayment penalty clause.
Do reverse mortgages have these prepayment penalty clauses?
By law, reverse mortgages cannot have any form of a prepayment penalty clause. If for any reason the holder of a reverse mortgage wanted to make a partial or full payment on the loan they can do so at any time.
Why are prepayment penalties allowed on a regular mortgage but not a reverse mortgage?
A prepayment penalty defeats the purpose of a reverse mortgage. It grants homeowners access to equity without any repayment. Most borrowers gain nothing from early payments. They applied for the reverse mortgage to use some of their home equity without selling it or having to make monthly payments
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