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Hi tushars,

If there's a pre-payment penalty on my mortgage,
and I decide to re-finance, is this pre-payment
penalty tax deductible?

As with all legal and tax issues, you'll want the blessings of your local CPA...

That disclaimer out of the way; YES, prepayment penalties, if enacted, are considered "costs of credit" and are thus tax deductible in the year incurred (since they occur in relation to a loan that is closed that year.)

I read on this msg board, that pre-payment penalty
is illegal in some states .. is this true ??? :-)


if so, is it illegal in California ?? :-)

No, both hard and soft prepayment penalties are legal and allowable in California.

If you're being faced with this, make sure you're taking a SOFT prepayment penalty if you can help it. Soft prepayment penalties only apply if the loan is paid off greater than 20% of the origingal principal per year for reasons of refinance, but not in the case of a sale.

Soft prepayment penalties are usually beneficial to the borrower when the lender lowers the interest rate, or pays more rebate towards closing costs, in return for the borrower voluntarily accepting these refinance limitations.

If interest rates are so low you sincerely feel it's unlikely you would refinance within the limitation period, then a soft prepay penalty (refi limitation) is basically a free gift by the lender... why not grab it!

All the best to you in your upcoming closing!
Dave Donhoff
Foolish Mortgage Broker
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