Before the financial crisis, many mortgage contracts contained a provision stating that borrowers who paid off their loan early had to pay a penalty. Penalties were usually expressed as a percent of the outstanding balance at time of prepayment or a specified number of months of interest. In most cases, the penalties declined with the passage of time and usually disappeared entirely after five years or so. Partial prepayments of up to 20 percent of the balance usually were allowed in any one year without a penalty. Sometimes the penalty applied to a home purchase transaction as well as a refinancing, but more commonly it applied only to a refinance.
Prepayment penalties were never allowed on Federal Housing Administration or Veterans Affairs loans, but after the financial crisis Fannie Mae and Freddie Mac also barred them. Today, penalties are permitted only in the remaining sliver of the market not touched by the federal agencies — which is no more than 10 percent of the total. Many say “good riddance” but I view it as the loss of an option that some borrowers could use to their benefit.
