Are prepayment penalties for mortgages normal?
It used to be much more common, particularly for sub-prime loans. If you do run into someone offering a loan with a prepayment penalty, you should certainly consider other options. It's not uncommon to have a small penalty if you pre-pay the mortgage in a short time.  After all, making the loan isn't free for the bank. But as Nathan says, if a bank is planning to try very hard to stop you from giving them money, there is probably a reason. Try to convince your wife: there is nothing inherently wrong with debt.  Like anything, too much can be bad for you, but when debt is deployed wisely -- that is almost always, when it is used to finance a capital asset (an asset that produces value) -- it can be a very good thing. "Fannie Mae and Freddie Mac uniform loans do not have prepayment penalties, so most plain-vanilla loans from national banks and brokers shouldn't have the penalty.  (Fannie Mae rules are categorical; Freddie Mac will buy loans with prepayment if the loan originator documents that a loan without prepayment was offered and the borrower made the choice for other considerations; the uniform instrument they share conforms to the more restrictive rules) ""Mortgage loans subject to prepayment penalties will be ineligible for sale to Fannie Mae"" Fascinating historical discussion of how the two GSEs negotiated the compromise uniform form back in 1975 Exotic terms, subprime, jumbo loans, ARMs, construction loans, secondary loans or really local banks where they'll hold the loan are cases where there might be a prepayment penalty." Mortgages with a prepayment penalty usually do not charge points as a condition of issue. The points, usually in the range 1%-3% of the amount borrowed, are paid from the buyer's funds at the settlement, and are effectively the prepayment penalty.  Once upon a time (e.g. 30 years ago), in some areas,  buyers had a choice of  This last option usually had a higher interest rate than the first two. It was advantageous for a buyer to accept this option if the buyer was sure that the mortgage would indeed be paid off in a short time, e.g. because a windfall of some kind (huge bonus, big inheritance, a killing in the stock market, a successful IPO) was anticipated, where the higher interest charged for only a few years did not make much of a difference. Taking this third option and hanging on to the mortgage over the full 15 or 20 or 25 or 30 year term would have been a very poor choice. I do not know if all three options are still available in the current mortgage market. The IRS treats points for original morttgages and points for re-financed mortgages differently for the purposes of Schedule A deductions. Points paid on an original mortgage are deductible as mortgage interest in the year paid, whereas points paid on a refinance must be amortized over the life of the loan so that the mortgage interest deduction is the sum of the interest paid in the monthly payments plus a fraction of the points paid for the refinance. The undeducted part of the points get deducted in the year that the mortgage is paid off early (or refinanced again). Prepayment penalties are, of course, deductible as mortgage interest in the year of the prepayment.
Forget about terms.  Think about loans in terms of months.  To simplify things, let's consider a $1000 loan with .3% interest per month.   This looks like a ten month term, but it's equally reasonable to think about it on a month-to-month basis.  In the first month, you borrowed $1000 and accrued $3 interest.  With the $102 payment, that leaves $901 which you borrow for another month.  So on and so forth.   The payoff after five payments would by $503.54 ($502.03 principal plus $1.51 interest).  You'd save $2.99 in interest after paying $13.54.  The reason why most of the interest was already paid is that you already did most of the borrowing.  You borrowed $502.03 for six months and about $100 each for five, four, three, two, and one month.  So you borrowed about $4500 months (you borrowed $1000 for the first month, $901 for the second month, etc.).  The total for a ten month $1000 loan is about $5500 months of borrowing.  So you've done 9/11 of the borrowing.  It's unsurprising that you've paid about 9/11 of the interest.   If you did this as a six month loan instead, then the payments look different.  Say  You borrow $1000 for one month.  Then 834 for one month.  So on and so forth.  Adding that together, you get about $168.50 * 21 or $3538.50 months borrowed.  Since you only borrow about 7/9 as much, you should pay 7/9 the interest.  And if we adding things up, we get $10.54 in interest, about 7/9 of $13.54.   That's how I would expect your mortgage to work in the United States (and I'd expect it to be similar elsewhere).  Mortgages are pretty straight-jacketed by federal and state regulations.   I too once had a car loan that claimed that early payment didn't matter.  But to get rid of the loan, I made extra payments.  And they ended up crediting me with an early release.  In fact, they rebated part of my last payment.  I saved several hundred dollars through the early release.  Perhaps your loan did not work the same way.  Perhaps it did.  But in any case, mortgages don't generally work like you describe. i prepaid roughly $400 at closing into escrow. that's my minimum allowable balance. paid in all year, and now taxes and insurance are paid in december. after december, they're projecting a $200 balance, which is $200 too low. homeowners insurance hasn't changed, pmi hasn't changed, property taxes are virtually identical to estimate at closing. the difference is that the $400 initial payment didn't factor in timing of those payments out of escrow. pretty lame if you ask me. "For the mortgage, you're confusing cause and effect. Loans like mortgages generally have a very simple principle behind them: at any given time, the interest charged at that time is the product of the amount still owing and the interest rate. So for example on a mortgage of $100,000, at an interest rate of 5%, the interest charged for the first year would be $5,000. If you pay the interest plus another $20,000 after the first year, then in the second year the interest charge would be $4,000. This view is a bit of an over-simplification, but it gets the basic point across. [In practice you would actually make payments through the year so the actual balance that interest is charged on would vary. Different mortgages would also treat compounding slightly differently, e.g. the interest might be added to the mortgage balance daily or monthly.] So, it's natural that the interest charged on a mortgage reduces year-by-year as you pay off some of the mortgage. Mortgages are typically setup to have constant payments over the life of the mortgage (an ""amortisation schedule""), calculated so that by the end of the planned mortgage term, you'll have paid off all of the principal. It's a straightforward effect of the way that interest works in general that these schedules incorporate higher interest payments early on in the mortgage, because that's the time when you owe more money. If you go for a 15-year mortgage, each payment will involve you paying off significantly more principal each time than with a 30-year mortgage for the same balance - because with a 15-year mortgage, you need to hit 0 after 15 years, not 30. So since you pay off the principal faster, you naturally pay less interest even when you just compare the first 15 years. In your case what you're talking about is paying off the mortgage using the 30-year payments for the first 15 years, and then suddenly paying off the remaining principal with a lump sum. But when you do that, overall you're still paying off principal later than if it had been a 15-year mortgage to begin with, so you should be charged more interest, because what you've done is not the same as having a 15-year mortgage. You still will save the rest of the interest on the remaining 15 years of the term, unless there are pre-payment penalties. For the car loan I'm not sure what is happening. Perhaps it's the same situation and you just misunderstood how it was explained. Or maybe it's setup with significant pre-payment penalties so you genuinely don't save anything by paying early." That's why they're taking the deal. But it's not like they completely stole all that money. I don't have any stats, but I'd assume most of those people who got their loans are still in their homes. (Sorry, I could be way off. Please correct) But they still are bastards for not letting me refinance. Could have just been because they saw this penalty coming. A few years ago I had a 5 year car loan. I wanted to prepay it after 2 years and I asked this question to the lender. I expected a reduction in the interest attached to the car loan since it didn't go the full 5 years. They basically told me I was crazy and the balance owed was the full amount of the 5 year car loan. This sounds like you either got a bad car loan (i.e. pay all the interest first before paying any principal), a crooked lender, or you were misunderstood.  Most consumer loans (both car loans and mortgages) reduce the amount of interest you pay (not the _percentage) as you pay down principal. The amount of interest of each payment is computed by multiplying the balance owed by the periodic interest rate (e.g. if your loan is at 12% annual interest you'll pay 1% of the remaining principal each month). Although that's the most common loan structure, there are others that are more complex and less friendly to the consumer. Typically those are used when credit is an issue and the lender wants to make sure they get as much interest up front as they can, and can recover the principal through a repossession or foreclosure. It sounds like you got a precomputed interest loan.  With these loans, the amount of interest you'd pay if you paid through the life of the loan is computed and added to the principal to get a total loan balance. You are required to pay back that entire amount, regardless of whether you pay early or not. You could still pay it early just to get that monkey off your back, but you may not save any interest.   You are not crazy to think that you should be able to save on interest, though, as that's how normal loans work.   Next time you need to borrow money, make sure you understand the terms of the loan (and if you don't, ask someone else to help you). Or just save up cash and don't borrow money ;) In the prior PMI discussions here, it's been stated that the bank is not obligated to remove PMI until the mortgage's natural amortization puts the debt at 78% LTV. So, paying in advance like this will not automatically remove the PMI.  Nor will a lump sum payment be certain to move the next payment ahead a year. If it's entered as a principal prepayment, the next month's payment is still due. In the world of coupon books, if you sent in a year's payments, you'd not benefit from the interest saved, in one year you'd owe what the amortization table tells you.  There's no free lunch when it comes to mortgages or finance in general. This is why we usually caution that one should not be cash poor the day after buying a house. Best to save 30%, put down 20%, and have a cushion after the closing. Each goes to a different agency. Yes, it is normal that the lender queries more than one agency. yeah, i get that it's not optional. just sucks that nothing has changed substantially since i closed on the loan 11 months ago (same PMI, same HO, essentially the same property taxes) and now i have to pay more. seems like the closing docs could have taken into account timing of those payments so that i primed the pump with enough from the beginning. This may only apply to Canada, but I would ask if the mortgages they lend are non-transferable. Meaning if you decide in year 2 of your 5 year term that you want to sell and move you pay a penalty, rather than be able to transfer the mortgage to a new house. "Assuming you've got no significant prepayment penalty, I would think about getting a longer mortgage, but making payments like it was a shorter mortgage. This will get the mortgage paid off in a shorter time period - but if you run into financial difficulties and/or find a better use for your money, you can drop back to paying the minimum necessary to retire the loan in 30 years without needing to refinance. (If you need to reduce your payments because you're between jobs, you don't have a very good negotiating position).  For the most part, there's nothing that says you can only make one payment per month, or that it must be in the amount printed on the statement. If you want to, you can make payments weekly (or biweekly, or every 4 weeks) which typically means that you'll pay more every year. If your mortgage payments are $1000/month, that's $12,000 per year. If you tell yourself that 1000/month = $250 weekly and make yourself send a payment every week (or 500 every 2 weeks), you'll end up paying 250 * 52 = $13,000 per year, without particularly feeling the difference, especially if you get paid on a weekly/biweekly schedule instead of monthly or semi-monthly. Also, by paying more often, you're borrowing a tiny bit less money over the course of the year (because the money didn't sit in your account waiting until the 1st of the month to make a payment) so you save a little in interest there, too.  Think of ""30 years"" or ""10 years"" as the basis for a minimum payment schedule, not necessarily the length of time that you or the lender really intend to keep the loan." "One way to think of the typical fixed rate mortgage, is that you can calculate the balance at the end of the month. Add a month's interest (rate times balance, then divide by 12) then subtract your payment. The principal is now a bit less, and there's a snowball effect that continues to drop the principal more each month.  Even though some might object to my use of the word ""compounding,"" a prepayment has that effect. e.g. you have a 5% mortgage, and pay $100 extra principal. If you did nothing else, 5% compounded over 28 years is about 4X. So, if you did this early on, it would reduce the last payment by about $400. Obviously, there are calculators and spreadsheets that can give the exact numbers.  I don't know the rules for car loans, but one would actually expect them to work similarly, and no, you are not crazy to expect that. Just the opposite." Take some of the commentary on home buying forums with a grain of salt. I too have read some of the commentary on these forums such as myFICO, Trulia, or Zillow and rarely is the right advice given or proper followup done. Typical 401k withdrawals for home purchase would not be considered a hardship. However, most employer 401k plans will allow you to take a loan for 401k as long as you provide suitable documentation: HUD-1 statement, Real Estate Contract, Good Faith Estimate, or some other form of suitable documentation as described by the plan administrator.  For instance, I just took a 401k loan to pay for closing costs and I had to provide only the real estate contract. Could I not follow through with the contract? Sure, but what if I am found out for fraud? Then the plan administrator would probably end up turning the distribution into a taxable distribution. I wouldn't go to jail in this hypothetical situation - I am only stealing from myself. But the law states that certain loan situations are not liable for tax as long as that situation still exists. In the home loan situation, my employer allows for a low interest, 10 year loan. My employer also allows for a pre-approved loan for any purpose. This would be a low interest, 5 year loan.  There is also the option to not do a loan at all. But normally that is only allowed after you have exhausted all your loan options and the government makes it intentionally harsh (30% penalty at least) to discourage people from dumping their tax free haven 401k accounts. That all being said, many plans offer no prepayment penalty. So like my employer has for us, I can pay it all back in full whenever I want or make micropayments every month. Otherwise, it comes out of my pay stub biweekly. So if it were to fall through, I could just put it all back like it never happened. Though with my plan, there is a cooling off period of 7 days before I can take another loan. Keep in mind that if you leave your employer then the full amount becomes a taxable distribution unless you pay it back within a certain period of time after leaving the employer.  Whether this fits your financial situation is up to you, but a loan is definitely preferred over a partial or full withdrawal since you are paying yourself back for your rightly earned retirement which is just as important. Are my mortgage terms locked in? Who oversees this? Yes your terms like rate, balance, penalties, due dates, are all covered in the mortgage documents. Those will not change. If the mortgage is an adjustable or has a balloon payment those terms will be followed by the new company. That being said, mistakes can be made. Double check everything. I had a transfer get messed up once, and all the terms were wrong. It took a few months but everything was worked out. In fact because they first tried to stonewall me I was able to negotiate some additional concessions out of them. Running your own escrow account is one thing you always want to do. That makes sure that the taxes and insurance are always paid by you, even if the servicing company has a glitch. Generally you have to have enough equity to not have PMI in order to get them to agree to the self-escrow option. If you have a problem with the servicing company then contact the Consumer Finance Protection Bureau a part of the US Government. They have only been a round a few years, thus I have no experience with them. Have an issue with a financial product or service? We'll forward your   complaint to the company and work to get a response from them. The last few times I applied for a mortgage or refinanced a mortgage the lender had to reveal as part of the application stage the percentage of recent mortgages they still own/service. Check those numbers the next time you apply. Different bonds (and securitized mortgages are bonds) that have similar average lives tend to have similar yields (or at least trade at predictable yield spreads from one another). So, why does a 30 year mortgage not trade in lock-step with 30-year Treasuries? First a little introduction: Mortgages are pooled together into bundles and securitized by the Federal Agencies: Fannie Mae, Freddie Mac, and Ginnie Mae. Investors make assumptions about the prepayments expected for the mortgages in those pools. As explained below: those assumptions show that mortgages tend to have an average life similar to 10-year Treasury Notes.  100% PSA, a so-called average rate of prepayment, means that the prepayment increases linearly from 0% to 6% over the first 30 months of the mortgage. After the first 30 months, mortgages are assumed to prepay at 6% per year. This assumption comes from the fact that people are relatively unlikely to prepay their mortgage in the first 2 1/2 years of the mortgage's life. See the graph below.  The faster the repayments the shorter the average life of the mortgage. With 150% PSA a mortgage has an average life of nine years. On average your investment will be returned within 9 years. Some of it will be returned earlier, and some of it later. This return of interest and principal is shown in the graph below:  The typical investor in a mortgage receives 100% of this investment back within approximately 10 years, therefore mortgages trade in step with 10 year Treasury Notes. Average life is defined here: The length of time the principal of a debt issue is expected to be   outstanding. Average life is an average period before a debt is repaid   through amortization or sinking fund payments. To calculate the   average life, multiply the date of each payment (expressed as a   fraction of years or months) by the percentage of total principal that   has been paid by that date, summing the results and dividing by the   total issue size. You mentioned 15-20 years in your comment on mhoran_psprep's response. This is the most important factor to consider in the points vs. rate question. With a horizon that long it sounds like the points are probably a better option for you. There is a neat comparison tool at The Mortgage Professor's website that may help you build your spreadsheet or simply check the numbers you are getting.