One thing you read about in connection with subprime and other loans is to beware of prepayment penalties. Maybe it's the word 'penalty' that makes this feature seem sinister. However, lenders don't expect something for nothing -- by agreeing to refrain from retiring your mortgage for a certain number of years you make lending to you a safer investment for the lender -- and there can be substantial rewards involved.

For example, you may be offered a lower rate. Or a discount on the loan fees. To determine if accepting a prepayment penalty is a smart move, consider the following:

1. The type of penalty. Prepayment penalties come in two forms, "hard" or "soft." "Hard" prepays are assessed whenever the loan is paid off before the penalty period expires -- this means if the property is sold, if you refinance, or sometimes even if you make a substantial principal reduction (lump sum payment), often anything exceeding twenty percent of the original balance. "Soft" prepayment penalties come into play only in the event of a refinance or substantial repayment -- if you sell the home you don't have to pay it. So if you think you might sell within the penalty period you wouldn't want to have a hard prepayment penalty but a soft one would be okay.

2. The terms of your loan. Many subprime loans involve a period in which the rate is fixed, then the mortgage converts to an adjustable rate mortgage. Bad credit ARM terms might not be favorable so you should avoid a prepayment penalty period that exceed the fixed rate part of the loan. For example, if the rate is fixed for the first two years of the mortgage, don't take on a 3-year prepayment penalty.

3. The size of the reward. If taking on a prepayment penalty gets you a lower rate, a mortgage calculator can show you the difference in monthly payment and how much you would save during the time you expect to keep your mortgage. If the lender offers you a few hundred dollars in exchange for a 5 year prepayment penalty it's probably not enough.

Like most mortgage loan products and features, prepayment penalties are not inherently good or evil. They can save you money when taken at the right time and for the right reasons.