Mortgage Prepayment Penalty Rules: When a Penalty Is Allowed

Published by the Modern Lending Solutions editorial team. Last reviewed: October 30, 2026.

Short answer: under federal rules, a home loan covered by the ability-to-repay rule may carry a prepayment penalty only if it has an APR that cannot rise, is a qualified mortgage, and is not a higher-priced mortgage loan. Even then, the penalty must end after three years and is capped at 2 percent of the balance prepaid in the first two years and 1 percent in the third, and the creditor must also offer you a loan without a penalty. High-cost mortgages may not have one, and FHA, VA and USDA guaranteed loans let you prepay without a charge. This page covers federal law only. It is general information, not legal or financial advice.

What counts as a prepayment penalty

For a closed-end loan, Regulation Z defines a prepayment penalty as a charge for paying all or part of the principal before it is due, other than a waived, bona fide third-party charge that the creditor imposes if you pay off the whole loan within 36 months (12 CFR 1026.32(b)(6)(i), eCFR, text up to date as of October 28, 2026, read October 30, 2026); the ability-to-repay rule uses the same meaning (1026.43(b)(10)). The CFPB describes it as a fee some lenders charge if you pay off all or part of your mortgage early, and suggests asking for a quote on a similar loan without one so you can compare total costs (CFPB, last reviewed September 11, 2024, read October 30, 2026; this page is older and may be out of date).

When a penalty is allowed

A covered transaction must not include a prepayment penalty unless the penalty is otherwise permitted by law and the loan (12 CFR 1026.43(g)(1), eCFR):

has an annual percentage rate that cannot increase after consummation;
is a qualified mortgage under 1026.43(e)(2), (e)(4), (e)(5), (e)(6) or (f); and
is not a higher-priced mortgage loan as defined in 12 CFR 1026.35(a).

So an adjustable-rate loan, a loan that is not a qualified mortgage, and a higher-priced loan may not carry one under this rule. See the higher-priced loan rule and the qualified mortgage points and fees cap.

The caps

Where a penalty is allowed, it must not apply after the three-year period following consummation, and it must not exceed 2 percent of the outstanding balance prepaid during the first two years, or 1 percent during the third year (12 CFR 1026.43(g)(2)).

The required offer without a penalty

A creditor must not offer you a loan with a prepayment penalty unless it also offers an alternative without one that has an APR that cannot rise and the same type of rate (fixed or step-rate), the same loan term, meets the qualified mortgage payment and points and fees conditions, and is a loan the creditor in good faith believes you likely qualify for (12 CFR 1026.43(g)(3)). If the offer comes through a mortgage broker, the creditor must give the broker that alternative and require by agreement that the broker present it to you (1026.43(g)(4)).

What the statute says

The Truth in Lending Act bars prepayment penalties on a residential mortgage loan that is not a qualified mortgage, excludes adjustable-rate loans and loans priced above set thresholds over the average prime offer rate from qualified mortgages for this purpose, and requires a creditor offering a loan with a penalty to also offer one without (15 U.S.C. 1639c(c)(1), (c)(4), LII, read October 30, 2026). The statute phases penalties out at 3, 2 and 1 percent of the outstanding balance over the first three years (1639c(c)(3)); Regulation Z sets a lower 2 percent cap for the first year, so the regulation is the stricter limit.

High-cost mortgages

A high-cost mortgage may not include a prepayment penalty (12 CFR 1026.32(d)(6)). A loan also becomes a high-cost mortgage if the contract lets the creditor charge a prepayment penalty more than 36 months after consummation, or penalties that can total more than 2 percent of the amount prepaid (1026.32(a)(1)(iii)). See high-cost home loan protections.

FHA, VA and USDA loans

Loan	Rule	Source
FHA	The mortgage must let you prepay in whole or in part at any time and in any amount, with no charge for prepaying	24 CFR 203.22(b)
VA	You may prepay at any time without premium or fee, the whole debt or any part of at least one installment or $100, whichever is less	38 CFR 36.4311
USDA guaranteed	Mortgages requiring prepayment penalties are ineligible terms	7 CFR 3555.104(b)

Sources: eCFR 24 CFR 203.22, eCFR 38 CFR 36.4311 and eCFR 7 CFR 3555.104, text up to date as of October 28, 2026. Under the VA rule, a full payoff is credited on the date received with no interest charged after it, while a partial prepayment made between due dates need not be credited until the next installment due date or 30 days later, whichever is earlier. Regulation Z notes that, for FHA loans consummated before January 21, 2015, interest charged under the monthly interest accrual method is not a prepayment penalty (1026.32(b)(6)(i)).

Example: the caps

This example is only for the math, with example balances on a fixed-rate qualified mortgage that is not higher-priced, not terms from any lender. It shows the largest penalty the rule allows, not what any loan charges.

Situation	Balance prepaid	Cap	Largest penalty allowed
Refinance in month 18	$296,000	2%	$296,000 × 2% = $5,920
Sale in month 30	$284,000	1%	$284,000 × 1% = $2,840
Extra payment in year two	$20,000	2%	$20,000 × 2% = $400
Payoff after month 36	Any	None	$0

The statute alone would allow 3% in the first year, or $296,000 × 3% = $8,880 on the same balance, but the regulation caps the first two years at 2%. Your contract may set a lower penalty, a shorter period, or none at all.

Where to find it on your papers

The Loan Estimate must say whether the loan includes a prepayment penalty, labeled “Prepayment Penalty” (12 CFR 1026.37(b)(4), eCFR). Check the Closing Disclosure and the note for the same term before you sign. Before a recast or refinance, see mortgage recast vs refinance; for other loans, see personal loan prepayment penalties.

Questions to ask the lender

Does this loan have a prepayment penalty, and what is the largest it could be in each year?
Does it apply to extra principal payments, or only to a full payoff?
What would the same loan cost without a penalty?
Is this a qualified mortgage, and is it a higher-priced mortgage loan?

Checklist

Find the “Prepayment Penalty” line on the Loan Estimate.
Compare the offer with the loan without a penalty that the creditor must also offer.
Note the date three years after closing; no penalty may apply after it.
On an FHA, VA or USDA guaranteed loan, question any prepayment charge.
For a dispute about a penalty already charged, talk to a lawyer.

To find housing counseling agencies that HUD has vetted, use the CFPB housing counselor search. You can submit a complaint at consumerfinance.gov/complaint.

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Sources

Disclosure: Modern Lending Solutions is not a lender, loan broker or agent for any lender or loan broker, and does not make credit decisions. Any compensation we receive is paid by participating lenders, only for advertising services. This guide is general information, not financial or legal advice.

Mortgage Prepayment Penalties: The Federal Rules