| "Prepayment penalties" have become one of those | | | | sub-prime loans because the risk ofrefinancing is |
| phrases that borrowers automatically assumeis | | | | higher than on prime loans. They do this because |
| negative when dealing with their mortgage lender. | | | | sub-prime borrowers arelooking to refinance from the |
| Prepayment penalties are not usually negative. They | | | | moment they take possession of their new home. |
| are simply misunderstood. | | | | A sub-prime borrower controls his own market. Even |
| The clients I speak with on a daily basis nearly all say | | | | if interest rates go up, he can still get hisrate down |
| the same thing, "my friend says I shouldask for a | | | | by simply improving his credit. Good credit borrowers |
| mortgage with no prepayment penalty." | | | | will only refinance if rates godown. |
| Unless you are looking to flip the property in under 12 | | | | Let's say that Bill is a sub-prime borrower with bad |
| months, which a lot of people have done in recent | | | | credit. He gets into a 30 year loan for |
| years, you should not be afraid of a prepayment | | | | 10.000%. At the same time, Chris, a good credit |
| penalty. In fact, they are often a good thing and can | | | | borrower, gets 6.000% for the same loan. |
| reduce your monthly payment substantially. | | | | If rates go to 7.000% in the next year, Chris has |
| "What is a Mortgage Prepayment Penalty?" | | | | absolutely no reason to refinance. Let's say thatover |
| A prepayment penalty is a written obligation, in your | | | | this same period, Bill works on his credit and is now |
| loan documents, that states that if you pay off the | | | | no longer considered a sub-primeborrower. He should |
| loan entirely, or a major part of it, before a certain | | | | be able to refinance at 7.000% or slightly higher. |
| period of time you will pay a penalty. | | | | The bank took a lot of risk on "bad-credit" Bill when it |
| You are usually offered a lower interest rate or | | | | originally loaned to him and now "better credit" |
| lower fees on your mortgage in exchange for | | | | Bill wants out. Because of the high costs and even |
| accepting this penalty. | | | | higher default rates in sub-primelending, it is not |
| The penalties are usually a preset percentage of the | | | | profitable if the good loans leave after only one to |
| outstanding balance of your loan at the time of | | | | two years. |
| prepayment or they can be a specified number of | | | | If you are sub-prime, still try and negotiate. Although |
| months of interest. | | | | you will probably have to accept some kindof pp |
| Most prepayment penalties I deal with are around six | | | | penalty, you will probably be able to negotiate the |
| month's interest. | | | | specifics of the deal. Even if you are able to get it |
| Let's say your mortgage payment is $1200/mo. Of | | | | waived for a fee, the cost may not make sense. |
| this, let's say that $1000 is interest. Now let'sassume | | | | Try and make it no longer than two years and see if |
| you have a two-year prepayment penalty. This | | | | they will give you a soft instead of a hard pp penalty. |
| means if you pay off your mortgage, infull, by selling | | | | Even with bad credit, you are still the customer and |
| the home or refinancing the mortgage before two | | | | the lender still wants to make a sale. |
| years have gone by you will pay aprepayment | | | | "How do I avoid getting duped?" |
| penalty to the bank of six months interest or $6000 | | | | I cannot tell you how many calls I receive from |
| as a penalty for early payoff. | | | | clients looking to refinance their home who |
| Sounds like a lot to pay. But as you will read below it | | | | don'tknow if they have a prepayment penalty. |
| may be of value. | | | | Then there are the times when they think they didn't |
| If you have a prepayment penalty, somewhere in | | | | have one only to have it show up in thepayoff |
| the body of your loan documents, you will also find a | | | | statement of the mortgage when we are getting |
| provision that usually allows you to up to pay up to | | | | ready to close the refinance. |
| 20% of the mortgage in any one year without a | | | | I have heard many nightmare stories about unethical |
| penalty. If you pay more than this the penalty kicks | | | | mortgage companies and their loan officersslipping |
| in. | | | | prepayment penalties into loans without the borrower |
| For example, if your mortgage is $300,000, you can | | | | knowing. The borrower does notcarefully review |
| pay up to $60,000 a year without the penalty taking | | | | what they are signing, they had no discussion about |
| effect. | | | | it prior, and they end up witha horrible, non-beneficial |
| There are two different kinds of prepayment | | | | prepayment penalty. |
| penalties. | | | | Prepayment penalties can go as high as five years. If |
| A "hard" prepayment penalty means that you cannot | | | | you are not paying attention, you could bestuck in |
| sell or refinance the home within theprepayment | | | | your loan, with no way out except a massive |
| penalty period. | | | | penalty, for a very long time. |
| A "soft" prepayment penalty only applies to a | | | | You should discuss prepayment penalties with your |
| refinancing. You can sell it at anytime withoutpenalty. | | | | loan officer at the very first meeting. If you are OK |
| You can't refinance it without penalty. | | | | with one, use it to your advantage to negotiate a |
| "What are the advantages of a prepayment penalty | | | | better rate. |
| mortgage?" | | | | Read your loan docs carefully at signing to make sure |
| You can usually get a lower interest rate and maybe | | | | they are exactly as agreed BEFORE yousign them. |
| even reduced fees. | | | | Ask the escrow officer at your signing or your loan |
| "What are the disadvantages of a prepayment | | | | officer to go over the prepayment |
| penalty mortgage?" | | | | penaltydocuments with you in detail. They are usually |
| If you pay off your mortgage in full before it is due | | | | clearly marked at the top like "PREPAYMENT |
| or if you choose to refinance your loan early, | | | | PENALTY RIDER." |
| youmay owe a substantial prepayment penalty. Once | | | | Don't accept any verbal promises. If it's not in writing |
| again, six month's interest is pretty standard. | | | | it does not exist. |
| "Why should I accept a prepayment penalty?" | | | | Don't sign any addendums after you have signed |
| Prime borrowers, with good credit, will usually get a | | | | your original loan docs without carefully reviewing |
| better interest rate if they accept a | | | | them. Once again, unethical lenders may try and get |
| prepaymentpenalty and they may even get | | | | you to sign a prepayment penalty addendum AFTER |
| discounted fees. Failure to accept a prepayment | | | | the fact. |
| penalty may result in higher rates and fees. | | | | Lenders sometimes make mistakes. We may ask |
| Think about it. You are the bank. Your client has | | | | you to sign note corrections and other formsafter it |
| asked you for a $300,000 loan. Your profitscome | | | | seemed like the transaction was complete. You even |
| from this client making years of interest payments | | | | sign an errors and omissionsstatement at closing that |
| on the loan. The fewer years your clientpays, the | | | | protects us when this happens. However, all |
| less profit to you. | | | | corrections should berelated to the deal as you |
| Thus, investors who buy loans from lenders in the | | | | accepted it in your discussions with your lender. |
| secondary market are willing to accept a lowerrate in | | | | If the lender made a mistake about a prepayment |
| exchange for a prepayment penalty. They want the | | | | penalty that you knew about and had agreed toyou |
| security of being able to count onyour payments. | | | | should sign this addendum. If you are presented an |
| The benefit of a prepayment penalty to them is that | | | | addendum for a prepayment penaltywith terms that |
| it discourages you fromrefinancing if interest rates | | | | you did not previously agree to, tell them to forget it. |
| decline in the future. | | | | "I was duped or I didn't know what I was getting |
| If you borrow money from them at 6.000% and the | | | | into. How do I get out of it now?" |
| rate drops to 5.000% at a later date but you stop | | | | The prepayment penalty is a contractual obligation no |
| yourself from refinancing due to a prepayment | | | | different than the rest of your loan docs. |
| penalty, it means even greater profits for thebank. | | | | The only way out of it is to get the other party to |
| However, you may save between .250% and .500% | | | | the contract to let you out. This is not very likely. |
| by accepting a prepayment penalty. On a | | | | Lenders have no reason to waive a prepayment |
| $300,000 loan, this can be between $50-100 per | | | | penalty. You are asking them for permission toend |
| month. $600-$1200 yearly. Its not a baddeal for | | | | your business relationship with them. |
| simply agreeing not to refinance for a while, especially | | | | In addition, borrowers call banks everyday trying to |
| when there is no way to predictfuture interest rates. | | | | get out of prepayment penalties that they knowingly |
| Even with these great benefits, most prime | | | | agreed to, especially when interest rates fall or they |
| borrowers avoid prepayment penalties. | | | | get an unexpected offer on their house that they |
| They do this because of the negative connotation | | | | can't refuse. They make up every excuse they can |
| that it got from someone who they trust orbecause | | | | think of to get rid of it. |
| they were simply never offered the option by their | | | | When you call to complain or say you were duped, |
| loan "expert." | | | | you will certainly not be the first caller that day crying |
| As you are aware, many loan officers barely know | | | | the same thing. |
| their loan programs let alone the benefits of | | | | One of my reps at one of the largest secondary |
| aprepayment penalty so they never give the | | | | banks in the country once told me that there was no |
| borrower the option. The borrower's friend | | | | legitimate excuse he could think of to warrant letting |
| orneighbor told them not to accept a prepayment | | | | someone out of the penalty. Not even death. |
| penalty, so they simply don't want it. | | | | You may have a better chance with a lawyer or the |
| This is very costly to your clients. Many more prime | | | | company that originated your loan. |
| borrowers would elect a prepayment penaltyoption if | | | | If you can convince the originating bank that you |
| they understood it. They just never get the chance. | | | | were "taken" by one of their loan officers and that |
| "How long a penalty should I accept?" | | | | theterms are far too strict, they may be able to |
| Choosing a prepayment penalty mortgage is a | | | | rewrite your prepayment penalty note and take |
| decision that primarily depends on both yourcurrent | | | | thefinancial hit from the secondary bank themselves. |
| financial situation and how long you think you'll keep | | | | Don't count on this. There is simply no excuse for |
| your mortgage before refinancing ormaking a very | | | | not having read your loan documents when you |
| large payment against it. | | | | signed them. Rule #1 in all contracts, "read before |
| The question you have to ask yourself is just like the | | | | you sign." |
| question you ask when considering anadjustable rate | | | | "What should I ask my lender about the prepayment |
| mortgage. How long will I be in this house?? How long | | | | penalty?"o Ask to see the document containing the |
| will I have this loan? | | | | prepayment penalty. Read it carefully.o Ask how |
| The other thing to consider is how good you believe | | | | much the penalty is that you'll be required to pay if |
| your interest rate compared to where it willgo. You | | | | you are penalized.o You want to know all of the |
| don't want to be boxed into a prepayment penalty, | | | | ways that the prepayment penalty will be triggered.o |
| see rates go way down, and then notbe able to | | | | Ask exactly how much you'll save on your closing |
| react and refinance. | | | | costs or fees if you take a prepayment penalty.o |
| I suggest you check out the rates for your loan with | | | | How about the rate? How much lower will it be?o |
| no pp penalty, with a one year pp penalty,and then | | | | Does the prepayment penalty apply when I sell too? |
| with a two-year pp penalty. You really don't want to | | | | Or just when I refi?o How is the penalty going to be |
| be penalized for selling your homeso try and get the | | | | calculated?o When can you start prepaying and not |
| penalty to be a "soft" prepayment penalty. | | | | suffer the penalty? |
| If you are positive that you will not be selling this | | | | The bottom line is this...if you have good credit, you |
| house for a while, consider the "hard" penaltiesas well. | | | | will usually not be required to have aprepayment |
| A penalty of six months interest, payable only on | | | | penalty. However, having one may lower your rate |
| refinancing within two years, is a veryreasonable | | | | pretty substantially. |
| price to pay for a .25%-.50% reduction in rate. You | | | | It's important you know how much this option is |
| can save $1,000's in the shortterm and $10,000's | | | | saving you so that you can make the best decsion |
| over 30 years. | | | | on your loan. |
| When I purchased my own home, I accepted a hard | | | | If you have bad credit, you may be required to have |
| one-year prepayment penalty. Rates wentdown and | | | | a prepayment penalty to allow the lender tobenefit |
| I refinanced it after one year. I accepted another | | | | from some of the risk he is taking by loaning you |
| one-year hard prepayment penalty. Itpushed my rate | | | | money. Asking that it be waived may be |
| further down in both cases. | | | | cost-prohibitive. |
| "Do I have an option on a prepayment penalty if I | | | | Either way, it is important for you to openly discuss |
| am a sub-prime borrower?" | | | | this with your lender from the very first meeting. |
| Lenders generally demand prepayment penalties on | | | | |