How Prepayment Penalties Can Impact Home Loans?

Summary: Prepayment charges apply when you take a loan and clear the entire payment before the due date. Prepayment penalties are usually decided beforehand when the loan agreement takes place. Read on to find out how this can impact your Home Loan.

A lot of the time, people take loans but clear the entire payment before the due date. In such cases, lenders charge a prepayment fee. The prepayment fee is designed so that the lender can recover the amount they would have received as interest if the borrower continued to pay the Home Loan throughout the loan tenure. Paying off your Home Loans earlier than the due date can have significant financial implications. 

While a Home Loan EMI calculator online may help you know the EMI, it may not help you work out prepayment charges. 

In this article, we will discuss different aspects of the prepayment of Home Loans. 

How are Prepayment Penalties Structured?

Prepayment penalties are usually decided beforehand when the loan agreement takes place. It depends entirely on the lender and the type of loan the individual is opting for.

It may also be defined as a percentage of the outstanding loan.

Several lenders have a time limit for the prepayments. For instance, some lenders only impose a time limit for the first four years of the loan. Borrowers may decide to clear the loans early. 

In this case, the penalty for the prepayment of the Home Loan will automatically get added to the remaining loan balance.

Perks of Prepayment Penalties

Prepayment penalties provide many benefits for lenders, which is why they continue to be a part of the agreements. Such penalties give lenders a stable income of interest rates from the borrowers. 

The lenders can manage the cash flow and reduce the risk at the same time. If the borrower pays the loan early, the lender may be stuck with cash flow, the cost of originating or servicing the loan.

How Do Penalties Affect Home Loans?

Penalties do have significant benefits for lenders. However, the borrowers will face several drawbacks if there is any such clause in the agreement. Firstly, the prepayment penalties increase the cost of borrowing money drastically. As mentioned earlier, the penalty gets added to the remaining loan amount, which can amount to several thousands of dollars or higher. If you wish to refinance your home or sell it, this factor will make it difficult for you to do so.

Borrowers often hesitate to pay such a hefty amount, and some may not even afford it. Alongside this, it greatly impacts the flexibility of the borrowers. 

Usually, a borrower takes a loan at fixed rates. With a prepayment penalty, the interest rates will drop drastically. However, they may not be able to refinance their loan without paying the penalty. In case of emergencies, if someone needs to sell the house immediately, this aspect will always become a hindrance.

How to Avoid Prepayment Penalties

If you plan to take a Home Loan anytime soon, reviewing the loan agreement carefully is highly recommended. Seek professional help if the need is and go through the agreement to understand if there is any prepayment penalty.

Try to find a house loan that has no penalty. If this is not possible, go for a loan that offers you low penalties and flexible options. For those who already have a loan with a prepayment penalty, try to negotiate with the lender and bring the penalty as low as possible.

Also, use a Home Loan EMI calculator online to make informed decisions about taking a loan and managing your finances.

Ensure that the early repayment of the loan does not clash with any of your financial goals. Do consider the tax benefits and never opt for a higher EMI amount just to shorten the tenure of the loan.

Final Words

Most borrowers try to repay the Home Loan as early as possible. However, prepayment of Home Loans comes with a fee that may significantly offset the savings on the interest. 

Consider all the pros and cons and then make a decision. Do not forget about your future needs for funds. For example, you may need money immediately or in the short term for some emergencies. So plan your budget and set an amount aside always.

Also check – A Step-By-Step Guide To Using A Home Renovation Loan To Finance Your House Renovation