Question: I made a huge mistake recently when refinancing my house. I did a first mortgage that is interest-only for 10 years with a three-year prepayment penalty of six months of interest unless we sell after one year, then no prepayment penalty. On the second mortgage, it is fixed for 15 years with a balloon payment and two years prepayment penalty. Is there anything I can do to change this or redo the loan without it costing me a lot of money?
J.S., Everett
Answer: I am very sorry to hear about your situation and I wish I had some good news for you, but unfortunately I do not.
A prepayment penalty is part of a legal contract with the lender that you signed when you closed your loan. We have had many people come to our mortgage company over the years and ask for help breaking the prepayment clause on their loans but there is simply no way to do it. You agreed to those terms when you signed the loan closing papers and the lender will hold you to them.
Here’s why:
The investors who provide the funds for mortgage loans pay a premium to the mortgage companies if they include a prepayment penalty in the loan because then the investor is guaranteed to earn a certain rate of return for at least the length of the prepayment penalty. Without such a penalty, the investors might get paid off in as little as six months when they were counting on receiving income from the loan over three years. Therefore, they will pay less to the mortgage companies for loans without prepayment penalties.
So you can see why the lenders have no incentive to let you off the hook. They paid a premium to lock you into a loan with a prepayment penalty and they would be losing some of the expected interest income from the loan if they let you pay it off early.
And you can also see why some loan officers like to sell loans with prepayment penalties. They make more money.
There are other reasons why a prepayment penalty might be included in a loan. Most subprime mortgage loans made to borrowers with poor credit ratings contain prepayment penalties because those kind of loans carry very high interest rates and investors want to lock them in for as long as possible to compensate for making such a high-risk investment. Prepayment penalties can also be used for loans to borrowers with good credit where the lender is willing to charge a lower interest rate in exchange for locking the borrower into the loan for a minimum amount of time, typically two or three years.
Your loan officer should have explained the pros and cons of the prepayment penalty clause to you before you signed the closing papers. Unfortunately, some loan officers are more interested in making a big commission than in taking care of their customers’ best interests.
Again, I don’t have a good answer for you. You will have to wait until your prepayment penalties expire before you can refinance again. You might try to contact your mortgage lender and ask if the company would be willing to waive the prepayment penalty if you refinance your existing loan with them. Sometimes they will agree to that, but only if they can earn a reasonable rate of return on the new loan.
Learn from your mistake and let this be a warning to other readers who might be in a similar situation. Always read the fine print on your loan documents and ask lots of questions. Make sure you are not getting into a loan program that contains a prepayment penalty. Or, if you do, make sure there is a valid reason to do so, such as getting a below-market interest rate. Don’t let loan officers talk you into a mortgage with a prepayment penalty just so they can put more money in their pockets.
Mail your real estate questions to Steve Tytler, The Herald, P.O. Box, Everett, WA 98206 or e-mail him at economy@heraldnet.com.
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