We often get questions about prepayment penalties and whether the penalty period will apply if a homeowner sells the home rather than just prepays the mortgage.
Q: I just signed a contract on my house with a closing at the end of next month. I also bought a new house with same closing date. I have an existing mortgage on my home. Can I keep that mortgage and make the payments on it to avoid the early payout penalties? The prepayment penalty continues for another eight months.
A: Once you signed the contract to sell your home, you agreed to sell the home and give the buyer good clean title to the home. At settlement or closing, you must pay off any liens that are on the home, including your existing mortgage. The buyer won’t be able to close on the purchase of the home unless you have paid off your loan.
There are some loans that allow your buyer to assume your loan, but we doubt that is what you have in mind. Presumably, you’re selling your home and buying a more expensive home. You will need a new loan on the home you are buying and you’ll need to get the cash out of the home you are selling. At the settlement from the sale of your home, you will get the net after paying off your existing lender, paying your broker’s commission and all other fees and costs from the sale. In turn, you’ll use that money to buy the new home, pay all the costs and fees of the new home and will get a new loan from a new lender.
Your new lender will only give you a new loan on your home knowing that the old owner’s lender has been paid off and is no longer a valid lien on the home.
As you are towards the end of your prepayment period on the loan, you should check to see what amount is at issue. Some loans have a declining prepayment penalty amount and some only charge the prepayment penalty during the first couple of years into the loan. So as you get further into the loan, your prepayment penalty may be less and less. Try to figure out what your prepayment penalty amount is – unless you already figured that out – and they you may have to just add that fee into the other fees you are paying in the sale and purchase of your homes.
Over the last 10 years we have seen less and less loans with prepayment penalties. Some of those loans fell by the wayside after the Great Recession and many lenders opted for using traditional loan products without prepayment penalties. We have never been fans of loans with prepayment penalties. As interest rates fluctuate, buyers can usually lock in a mortgage today and decide later whether to refinance the loan or move, if they so wish. Prepayment penalties were out there as an incentive to keep homeowners locked into a loan for at least the first couple of years of the loan term.
Some homeowners got a benefit from the lower rate offered by the loan product but we never thought that the lower rate was worth the possibility of having to pay the prepayment penalty. Some loans had such a hefty prepayment penalty that homeowners might have to come to the closing with money to get out from under their loans when they sold their homes.
We’d suggest you talk to your lender and understand what your prepayment penalty amount is. Once you know that, if it makes sense and the month-to-month amount of the penalty declines substantially, you might want to see if your buyer and seller would grant you a month extension. However, we don’t know if you’d want to jeopardize both your deals trying to save a small amount of money, but only you can decide what is considered a small amount of money given your financial situation and decide how to proceed.
Ilyce Glink is the Publisher of ThinkGlink.com and the Founder/CEO of Best Money Moves. Sam Tamkin is a Chicago-based real estate attorney.