What Are “Prepayment” Penalties?
Prepayment penalties are fees charged directly to a client when they pay off their loan within a certain time frame. These prepayment penalties were common before the 2008 housing crash.
For example, a lender could charge a prepayment penalty of 1% if the client pays off or refinances their loan within the first year after the loan funds.
These penalties are not common in today’s market, but they occasionally pop up with loan terms of hard money loans and home equity lines of credit.
The goal of a prepayment penalty is to encourage the client to keep the loan for a minimum amount of time, often so the lender can mitigate risk factors with their loan. We’ve previously published a blog: Will Prepayment Penalties Return? where you can learn more.
What Are Mortgage EPO Penalties?
EPO penalties are fees that originating lenders pay whenever a client pays off their loan within four to six months of funding. Borrowers are not responsible for these fees – they are charged directly to the lender, but borrowers are encouraged not to pay off or refinance their loans right away to avoid saddling the originating lender with the fees.
When a loan is funded, the origination lender usually sells the loan on the secondary market. When an investor buys a loan on the secondary market, they want to protect their investment, so they place the early payoff penalties on the lender. This ensures that if a loan is paid off in the first few months, the investor always makes their minimum return.
Each investor has their own timeframe for the early payoff penalties, but we see most investors impose timelines of 120-210 days. Some investors require six timely mortgage payments to be made before lifting the penalty. Please note: the days start counting from the day the loan is sold on the secondary market, not the day the loan funded. It usually takes ~2-4 weeks for a loan to sell on the secondary market.
An EPO loan penalty will erase all of the profits that the originating lender earned on the loan, and often cause thousands of dollars in additional fees. For smaller lenders, they can be very damaging to the bottom line.
In any case, lenders do not want borrowers to refinance for six months so they can avoid large penalties or not eat significant upfront costs.
What does it mean if a loan is paid off?
A loan is typically paid off in one of three ways:
- The client refinances the loan. In this case, the original loan is paid off, and a new loan is taken out on the property. This will cause the mortgage lender to incur the EPO penalty. Oftentimes, a client will refinance into a lower interest rate to lower their principal and interest payment. Some clients also refinance into shorter-term mortgages to meet their financial goals.
- The client sells the home. In this case, the loan will be paid off before the new owner can close on the property.
- The client makes a lump sum payment to bring the loan balance to $0. In some cases, a client may not want to continue having a mortgage payment, so if they have access to extra money, they can just pay off the loan. Oftentimes, this happens when clients unexpectedly inherit a large sum of money. The client may also make extra mortgage payments to bring down the principal balance faster.
Frequently Asked Questions
What is an Early Pay Off (EPO) penalty in mortgage lending?
An EPO penalty is a fee charged to the originating lender when a borrower pays off their loan within a certain period after the loan is sold on the secondary market. Borrowers are not responsible for paying this fee directly, but they are encouraged to avoid paying off or refinancing their loan too quickly to protect their lender from significant financial losses.
How is an EPO penalty different from a prepayment penalty?
A prepayment penalty is charged directly to the borrower when they pay off their loan within a certain time frame, while an EPO penalty is charged to the lender, not the borrower. Prepayment penalties were more common before the 2008 housing crash and are rarely seen today outside of hard money loans and home equity lines of credit.
How long does the EPO penalty period typically last?
Most investors impose EPO penalty timelines of 120 to 210 days from the date the loan is sold on the secondary market, which is typically two to four weeks after the loan funds. Some investors require six timely mortgage payments before lifting the penalty. The exact timeframe varies by investor.
What happens to the lender if a loan is paid off early?
An EPO penalty can erase all of the profits the originating lender earned on the loan and often results in thousands of dollars in additional fees. For smaller lenders, this can be particularly damaging to their bottom line, which is why lenders encourage borrowers to wait at least six months before refinancing or selling.
What are the most common ways a mortgage loan gets paid off?
A loan is typically paid off in one of three ways: the borrower refinances into a new loan, the borrower sells the home, or the borrower makes a lump sum payment to bring the loan balance to zero. Each of these scenarios triggers a payoff of the original loan and can result in an EPO penalty to the lender if it occurs within the penalty window.
What should I do if I need to pay off my mortgage within the EPO period?
Not all early payoffs can be avoided. If you find yourself in a situation where you need to sell or refinance shortly after closing, the best step is to contact your lender as soon as possible. While it may not always be possible to avoid the EPO penalty entirely, giving your lender advance notice of the circumstances is always a good idea and can help them plan accordingly.
What should you do if you are paying off your mortgage early?
Mortgage lenders understand that some borrowers will not be able to avoid the EPO penalty. For example, if a client gets a new job in a different state 3 months after closing on their home, clients may need to sell their house much sooner than expected. We recommend always checking in with your lender to see if it’s possible to avoid the EPO. At the very least, giving the lender a heads up about the circumstance will never hurt.
Have questions? Schedule a time to chat with one of our expert Client Advisors today.
