Did you know that paying off a loan isn’t always the best decision? Lenders can hit you with a yield maintenance penalty for early loan payoff. First you’ve heard of this? Don’t worry, this edition of the ABCs of Mortgage will explain what is yield maintenance.
What is yield maintenance?
Paying off a credit card early? That’s great! But paying off a loan early? Not always the best decision. See, banks make money when you borrow money. That’s what your interest is. And for large loans, like a mortgage, they stand to make a lot of money over 15 or 30 years, as you pay that interest each month. That’s where yield maintenance comes in. It’s a prepayment penalty that allows the bank to still make what they were expecting if you pay off the loan early.
Do I have to pay a yield maintenance penalty?
Will you have to pay a fee? Not necessarily – it’s (kind of) up to you! Depending on what type of loan you decide, you may not have to worry about one at all. Basically, you could pick a loan option where you wouldn’t have to worry about a prepayment penalty fee at all. So that seems like a no-brainer: Why would anyone choose a loan with an extra fee, right?
Well, funny you should ask. Often times, a mortgage loan with a yield maintenance penalty comes with a super low mortgage rate. It’s a give and take on what works best for your situation. So if you don’t plan to sell or refinance your home before the end of your loan term, opting for a mortgage with yield maintenance could be a great idea!
Why is there a yield maintenance penalty?
Fair question: Why is there another fee you have to think about? No one gets happy to think they have to pay extra, on top of several thousands they’re already investing. But really, it’s not an extra fee. A yield maintenance penalty is you paying what you already agreed to pay the lender when it agreed to lend you the money. That agreement was based on the lender making profit from the loan during the course of the loan term. It’s an easier pill to swallow when you think about it that way. Just be sure to ask your loan officer if the loan you’re selecting comes with a yield maintenance prepayment penalty before you sign on the dotted line!
How do I calculate a yield maintenance penalty?
Bet you didn’t think there was going to be math on this quiz. Calculating a yield maintenance penalty can depend on the conditions of the market. If conditions are really good, then the potential prepayment loss to a lender from you paying off early may be minimal. Meaning, it could end up in just a small prepayment fee of just 1% of the principal balance (as Forbes Real Estate Council member Terry Parker says). Talk about a steal; at least, in comparison to the following option.
Otherwise, it’s a somewhat complicated equation where the lender subtracts the new rate from the old rate, and then divide that by the product of the principal balance, difference and the number of days until current loan matures. Got that? If not, just ask your loan officer what the exact number would be if you were to sell or refinance your home. That expertise is why you work with a loan officer in the first place!
OK, I’m caught up. Now what?
Now you’re a lot more informed on yield maintenance, and know to ask if it’ll apply to you when you start your home financing. Looking for a few more details, or wanting to start the mortgage process? That’s what your local loan officer is ready to tackle!