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Mortgage Prepayment Penalties – Mortgage Professor

October 12, 2001, Revised November 17, 2004, November 27, 2006

What Is a Mortgage Prepayment Penalty?

A prepayment penalty is a provision of your contract with the lender
that states that within the occasion you repay the loan completely, you’ll
pay a penalty. Penalties are often expressed as a % of the
excellent steadiness at time of prepayment, or a specified variety of
months of curiosity.

Normally, prepayment penalties decline or disappear with the passage of
time. Seldom do they apply after the fifth 12 months. Partial prepayments of
as much as 20% of the steadiness often are allowed in anyone 12 months with no
penalty. A penalty that applies to a house sale in addition to a refinancing,
is a “arduous” penalty; if it applies solely to a refinancing, it’s a “comfortable”
penalty.

Questions on prepayment penalties come from a number of kinds of
debtors, as illustrated by the letters beneath.

A Prepayment Penalty Might Decrease the Curiosity Charge on a Prime Mortgage

“We’re committing ourselves as much as the restrict of our capability to purchase the
home we wish. Our dealer stated we may cut back the speed from 7% to six.75%
if we accepted a prepayment penalty. This would scale back our fee by
$35 a month, which might assist loads. Ought to we?”

In all probability. The speed quotes point out you’re a prime borrower — which means
your credit score is nice and/or you make a really massive down fee.
Prime debtors can often get a greater rate of interest in the event that they settle for a
prepayment penalty. Lenders, and the buyers who purchase loans from
lenders within the secondary market, are keen to simply accept a decrease fee in
alternate for a prepayment penalty. The advantage of a prepayment penalty
to them is that it discourages refinancing if rates of interest decline in
the longer term.

Most prime debtors keep away from prepayment penalties, both as a result of they’ll
or as a result of they’re by no means supplied the choice. Mortgage officers often
press to shut as quickly as attainable, and providing choices slows down the
course of. The upshot is that many prime debtors who would elect a
prepayment choice in the event that they understood it, by no means get the possibility.

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It’s possible you’ll be candidate since you connect a excessive worth to the decrease
fee. The query you should think about is what you’re giving up? How
massive is the penalty? What number of years should elapse earlier than it goes away?
And does it apply solely to refinancing — you don’t need to be topic to
penalty for those who promote your own home. A 2-3% penalty in the course of the first 3-5
years, payable solely on a refinancing, is an inexpensive worth to pay for a
1/4% discount in fee.

A Prepayment Penalty Might Be Required on a Sub-Prime Mortgage

“As a result of I’ve very low credit score, I agreed to pay 11% for a 30-year
mortgage. Pals have warned me to keep away from a prepayment penalty, however when
I ask the loan officer about this, he says that the lender completely
requires it. Do I’ve any choices?”

In all probability not. Due to your low credit score, you’re a sub-prime borrower.
Lenders typically demand prepayment penalties on sub-prime loans as a result of
the chance of refinancing is larger than on prime loans. Sub-prime
debtors revenue from refinancing if their credit standing improves, even
when the overall degree of mortgage charges doesn’t change. Prime
debtors can revenue from refinancing provided that market rates of interest
decline.

For those who make all of your funds on time for the subsequent two years, and
assuming no change within the common market, you may be capable of refinance
your 11% loan at 7-8%. However your present lender needs to maintain your 11%
loan for greater than 2 years. Due to excessive origination prices and excessive
default prices, sub-prime lending just isn’t worthwhile if the great loans
stroll out the door after solely two years.

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However that doesn’t imply you haven’t any negotiating energy. Whilst you might not
be capable of negotiate away the penalty completely, you’ll most likely be
in a position to negotiate the specifics. Inform the loan officer: “Now not than
5 years; no larger than 3%; partial prepayments as much as 20% of the steadiness
allowed in any 12 months with out penalty; no penalty on sale of the
property.” Be forceful however candy, conserving in thoughts that the lender needs
your loan to shut.

Prepayment Penalties Are Not often Waived

“I’m a kind of dupes who by no means learn the observe. I now discover myself caught
with a 12% mortgage and a 5% prepayment penalty, which I can’t afford to
pay. Is there any approach to get out of it?”

The one approach to get out of a contractual obligation is to induce the
different get together to the contract to allow you to out. However lenders not often have a
cause to waive a prepayment penalty. Contemplating that you’re
terminating a relationship with them to start out anew with one other lender,
why would they? The lender will certainly say “no” for those who ask.

You may need an opportunity if the request comes from a extra formidable
supply. Some sub-prime debtors have discovered a neighborhood group keen to
intercede on their behalf. For those who persuade the neighborhood group that the
authentic phrases have been unreasonably onerous, they only may persuade the
lender to rewrite the observe.

Contract Chicanery Typically Includes Prepayment Penalties

The letter above was from a borrower who had been victimized by contract
chicanery: the follow of surreptitiously slipping a provision
disadvantageous to the debtors into the observe. (Ordinarily, the
borrower doesn’t see the observe till closing, and possibly doesn’t learn
it then. )Judging from my mail, prepayment penalties are the commonest
goal of contract chicanery. It may possibly simply be prevented, see

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Learn how to Store For a Mortgage and

Disclosure Guidelines on Mortgage Prepayment Penalties.

Do not Present a Prepayment Penalty to the Lender

“My lender has requested an addendum to my observe that he calls a comfortable
prepayment penalty. Mainly it states that if I prepay greater than 20%
of the loan inside 5 years I might want to pay a penalty equal to 6
months’ curiosity. If the property is offered I can have this penalty
waived. It’s unlikely that I’ll need to refinance my 6% fixed-rate
loan, so why would the lender request such a clause? Ought to I settle for
it?”

No. This lender evidently priced your loan with no penalty clause, and
now needs to insert it with none quid professional quo. Don’t let him.

When the lender sells your loan within the secondary market, it could be
price 1% extra with the prepayment penalty clause than with out. That
would, roughly, double his revenue on the deal. However a prepayment penalty
ought to carry a profit to you – maybe a 1/8% discount within the curiosity
fee.

Your present intentions concerning refinance sooner or later are wholly
irrelevant. If charges drop from 6% to 4%, you’ll most likely refinance.
Buyers within the secondary market perceive that, even for those who don’t. It
is why they’re keen to pay a premium worth for a penalty clause that
discourages refinancing.

Assuming you negotiate a penalty with the lender, ensure that a provision
to waive the penalty if the home is offered is included within the observe.
The lender who finally ends up proudly owning your loan received’t know something about any
oral guarantees.