Prepayment Penalties Tough Pill To Swallow

by Broderick Perkins DeadlineNews.Com The sub-prime lending boom in recent years may have opened the door to many borrowers who couldn't otherwise afford a home, but the trend also created a class of home owners who now can't benefit from refinancing to lower interest rate without paying a prohibitively costly prepayment penalty. Prepayment penalties can be as high as six months worth of interest payments on 80 percent of the balance on your mortgage. They typically are tacked onto mortgages by lenders to reduce their risk when making loans to borrowers with credit dings and other risk factors. Attached to loans that are already higher cost loans because of the borrowers qualifications have put them in a "subprime" category, the penalties are also designed to discourage borrowers from just what they may be after right now -- refinancing to take advantage of rates below 6 percent. The penalties evaporate after three or more years and some states outlaw them or severely restrict them. Last year Freddie Mac stopped buying subprime mortgages with penalties that exceed three years. Some penalties are trigged when the loan is retired in for any reason -- refinancing, a home sale, making additional principal payments. On other loans, the penalty must be paid only when the mortgage is refinanced or principal payments exceed a certain level. In any event, your broker, if you use one, should help steer you away from prepayment penalties and explain the details of any penalty you may choose to accept -- say to get a lower rate or so-called "zero-cost" loan that might tack on a prepayment penalty. The prepayment penalty is just one reason borrowers must take the time to read the small print or get someone qualified to scrutinize the loan papers. Once the prepayment penalty is included, it's typically carved in stone. "I have never heard of a lender who would waive a prepayment penalty for any reason. Lenders will take what the note allows," says Jack Guttentag, the "Mortgage Professor" a mortgage consultant in Wayne, PA. "If there are conditions of waiver, such as the penalty only applying to a refinance, not to a sale, it will be in the note. Occasionally, you hear from a borrower who says that the loan officer told her that if...there would be no prepayment penalty. Guess what? That loan officer doesn't work there anymore so she has to pay," Guttentag said. Some experts say there are rare occasions, say if you refinance with the same lender, when a prepayment penalty may be waived, but any waiver is at the lender's discretion. "Lenders can voluntarily waive prepayment penalties. They used to do this if you took a new loan with the same lender. This does not seem to be the case any more," said San Jose, CA real estate attorney David Hofmann. "Most lenders now understand when they can include prepayment penalties and will include them whenever they can. Most good loan brokers try to avoid having their clients agree to prepayment penalties, even if it means paying a little higher rate," Hofmann added. The best you can hope for is a tax deduction. A prepayment penalty is considered interest you can deduct on you tax return. An interest deduction, however, only reduces the amount of income against which you are taxed -- unlike a tax credit that directly reduces your taxes. "It certainly would be worth it, to try to get the lender to waive the penalties if you are going to be refinancing with the same lender. If you don't ask, you won't get the penalties waived," said Marie Sternberger, an enrolled agent in Sunnyvale, CA. Copyright © 2004 DeadlineNews.Com -- Broderick Perkins, is executive editor of San Jose, CA-based DeadlineNews.Com, an editorial content and consulting firm. Perkins has been a consumer and real estate journalist for more than 25 years.