Pre-payment penalties are an integral part of mortgage financing. They are contractual component of any competitively priced mortgage. This means you’ll be subject to pre-payment penalties for any extra amount you pay down and more significantly in the event that you pay off your mortgage entirely. Fortunately, most mortgages come with pre-payment privileges. These privileges allow you to make payments in addition to the contract minimums without incurring penalties. Pre-payment privileges come in 3 flavors; lump sum, payment increase and payment double-up.
Lump sum pre-payment privileges usually range between 10% and 20% of the original mortgage amount. For example, if you had a 15% lump sum pre-payment privilege on a $200,000 mortgage, then you could make an annual lump sum payment of $30,000 without penalty. Strictly speaking, you could only make this payment on the anniversary date of the mortgage. Lenders, however, are more flexible than this and will allow you some latitude; however it can be beneficial to know what lenders will best accommodate your needs. The most flexible lenders will let you make lump sum payments year-round so long as the total of the lump sum payments does not exceed the annual limit.
Payment increase privileges also typically range between 10% and 20%, but this time it’s of your existing regular payment amount. For example, if your mortgage payments were $1,000 per month and you were allowed to increase the payments by 15% each year, then you could increase your payment up to $1,150 per month in the first year. Similar to lump sums, you should familiarize yourself with your lenders policies. A good lender will allow you to make this payment increase any time during the year and even several times so long as the total of the increases doesn’t exceed the maximum allowed.
These pre-payment privileges are expressed as follows: 10/10, 15/15 or 20/20. I doesn’t matter if the first number is lump sum or payment increase because the lenders will always have the same number in both positions.
Double-up is exactly as it sounds and is the ability to double up one month of payments. When available this privilege is usually available only once per year. Occasionally you’ll find a lender that advertises a double up option instead the payment increase privilege. This double up option will allow you to increase your payments by as much as double for the duration of your term. It would be similar to a 20% increase each year in a 5 year term.
Although lenders use similar terminology to express their pre-payment privileges, the flexibility in which they allow you to apply your pre-payments is critical. Make sure you understand you lender’s policies and that you choose the lender that best meets your needs.