Should I accept a loan with a prepayment penalty?

Whether or not you should accept a loan with a pre-payment penalty depends largely on your future plans and reason for the penalty clause.

If you're a sub-prime borrower, you probably don't really have a choice. Pre-payment penalty clauses are required in most sub-prime loans. That's mainly because you're more likely to re-finance as you rebuild your credit and qualify for a lower interest rate. Lenders attach pre-payment penalties to try and discourage you from re-financing.

If you're a prime borrower, though, you have some options. Accepting a pre-payment penalty clause usually has some benefits, but you need to weigh them carefully.

Most pre-payment penalties expire after a few years. If you don.t intend to re-finance in the first few years, and a pre-payment penalty reduces your interest rate a little, then go ahead and accept the penalty clause.

If, however, you do intend to re-finance fairly soon, a penalty clause could cost you a lot of money, more than you gain in reduced interest rate.

You want to find out, too, if the penalty is "hard" or "soft." A "hard" penalty applies not only to re-financing, but to a home sale as well, whereas a "soft" penalty applies only to a re-finance. If you plan to be in your home for a just few years, avoid hard pre-payment penalties, as they could cost you a lot of money when you sell your home.