💸 What Is a Prepayment Penalty in Real Estate?

A Prepayment Penalty is a fee charged by a lender when a borrower pays off their mortgage early. This fee compensates the lender for interest they lose when the loan is paid ahead of schedule. Prepayment penalties are more common on certain types of loans, including older mortgages, subprime loans, and some investment or commercial loans.

How a Prepayment Penalty Works

A prepayment penalty applies when the borrower pays off a mortgage sooner than the loan terms anticipate. This may include refinancing, selling the home, or making large lump-sum payments.

Types of prepayment penalties include:

  • Soft prepayment penalty — Applies only when refinancing, not selling.
  • Hard prepayment penalty — Applies to both refinancing and selling.
  • Partial prepayment penalty — Applies only to large extra principal payments.

Lenders use prepayment penalties to protect against early payoff risk and recoup lost interest income.

Why a Prepayment Penalty Matters

Impact on Buyers:

  • Can make refinancing more costly.
  • May reduce the benefit of paying off the mortgage early.
  • Can affect loan choice and long-term financial planning.

Impact on Sellers:

  • Might reduce net proceeds when selling if the mortgage is paid off early.
  • Can influence the timing of selling or refinancing.
  • Important to review before accepting offers or planning a move.

Example of a Prepayment Penalty

Below are examples of how a prepayment penalty may appear in a real estate contract or loan document:

  • “Borrower agrees to pay a prepayment fee equal to 2% of the remaining loan balance if the loan is paid off within the first 24 months.”
  • “A prepayment charge applies if the borrower refinances the loan before the third year.”
  • “Early payoff within 36 months triggers a prepayment penalty based on six months of interest.”

Why Prepayment Penalties Matter for FSBO Sellers

FSBO sellers should understand whether their mortgage has a prepayment penalty because paying off a loan early when selling a home may trigger this fee. Knowing this cost upfront helps with pricing, negotiating, and net sheet calculations.

  • Ensures accurate seller net proceeds.
  • Helps avoid surprises during closing.
  • Useful when comparing buyer offer timelines.
  • Important for sellers planning to refinance before selling.

Listing with Flat Fee MLS through Brokerless keeps FSBO sellers informed and competitive.

🔗 Related Resources for Buyers & Sellers

Frequently Asked Questions

How much is a typical prepayment penalty?
Prepayment penalties often range from 1–3% of the remaining loan balance or the equivalent of several months of interest.

Are prepayment penalties legal?
Yes, but they must be disclosed clearly. Many states restrict or ban prepayment penalties on primary residence mortgages.

Do FHA, VA, or USDA loans have prepayment penalties?
No. Government-backed loans (FHA, VA, USDA) do not allow prepayment penalties.

Can I avoid a prepayment penalty?
Yes — depending on your loan terms. Some penalties only apply in early years or only when refinancing.