Your state laws may dictate the lender provide you with advance notice of such penalties before you sign, but when it comes to FHA loans, prepayment penalties are not allowed.

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Prepaying FHA Loans

Consumer advocate groups warn first-time homebuyers to read their loan contracts carefully, and to ask their lenders about things such as a due-on-sale clause and other “fine print” type clauses which may give a lender the ability to charge you penalties for early payment or demand payment in full under certain circumstances.

Fortunately, FHA loan regulations don’t allow some of these “fine print” clauses—especially those which give the lender undue power over the borrower. One excellent example is the FHA’s rules concerning early payments. When you apply for an FHA loan as a new borrower, it’s easy to assume that you’ll stay in the same property for a long time—even for the entire course of your FHA mortgage. But life doesn’t always work out that way. People get jobs in far away cities, change their minds about the places they live or simply grow out of that first home. When that happens you may wish to sell the property and make a new application for an FHA home loan.

That’s where prepayment comes in. If you sell or even refinance a home, you are in effect paying off the original loan early. Many subprime loans require the borrower to pay a penalty for prepayment, and this requirement is included in the contract. Because home loan paperwork is often lengthy and requires strict attention to the entire document, some first-time home buyers get overwhelmed by the documentation and miss important details like a prepayment penalty.

Your state laws may dictate the lender provide you with advance notice of such penalties before you sign, but when it comes to FHA loans, prepayment penalties are not allowed. FHA home loans are forbidden by law to contain prepayment penalties or a due on sale clause (except in specific circumstances where a due on sale clause is allowed when it’s connected with the use of tax-exempt bond financing.) A due-on-sale clause usually dictates you pay your loan off in full when you sell the home rather than signing a loan over to the new owners.

FHA mortgage rules governing these issues are designed to protect the borrower from unnecessary fees or hidden expenses. When a borrower comes to the FHA in good faith, FHA loan rules insure a fair transaction for both the lender and the borrower.

The FHA forbids issuing a fee for prepayment of an FHA home loan, but there is one instance where you may be required to pay a specific amount for paying early. If you pre-pay an FHA loan on any date other than your specified payment date—the first of the month--you may have to pay interest until the end of the month that you pre-paid. That is up to the lender’s discretion and this practice is allowed under FHA rules. If you want to refinance or sell your home, make sure you pre-pay the FHA loan on the first of the month to avoid paying additional interest.

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