Negotiating Mortgage Pre-payment Penalties

November 10, 2006 | Mortgage | 42 comments

There are many negotiable parts of the refinance process and over time we will get into all of them. Some of these include, appraisal fees, processing, administrative, origination, broker points, and for today’s topic pre-payment penalties.

Why would the bank care if you payoff the loan early? Isn’t that what they want?

No. The fact is they want you to keep any loan for at least 18 months and in most cases will see a loss if the loan is paid off within 6 months. As a result, the standard contract between lenders and the mortgage brokers include the “chargeback” of any points or rebates the lender paid to the broker for the loan if that loan is prepayed within 6 months.

Any loan can be aquired without a pre-payment penalty. The lender’s rate quote will be based on how long you guarantee to keep the loan. A borrower who wants the flexibility of no prepayment penalty will pay a rate higher than the borrower who will accept a 1, 2, or 3 year committment. The lender charges the higher rate to insure recapture of loan costs and profitablility sooner.

The standard prepayment penalty is 6 months interest. This can vary but 6 months is by far the most common. The prepayment penalty could be considered HARD (due whether you refinance or sell before the minimum period is up), or SOFT (due if you refinance before the minimum period expires but not if you sell). Some are a combination of the 2 (hard for 6 months, soft for the remainder of 2 years). In all cases it is up to you whether you want to accept it. Expect a rate of a half to 1 full percentage point difference to the rate depending on the type of loan. Longer term loans come with a 3 year prepayment penalty by default.

Long term fixed rates are higher than a fixed rate for 5 years. Why get a long term (over 5 year) fixed rate and not accept a 3 year committment to keep the loan? It is contradictive reasoning. If there is any reasonable doubt that you will be in the home for 3 years then you should be choosing a loan with a shorter term fixed period which will match with a shorter prepayment penalty. A 2 year fixed rate has a 2 year prepayment penalty by default. Again, this is negotiable but the rate you are quoted will be a direct result of this choice.

When applying for a loan the prepayment penalty should be disclosed when the rate is quoted, and certainly by the time and Good Faith Estimate is provided (although it will not appear on the GFE). It is not usually in writing on early documentation so be sure to ask when the rate is quoted.

Next week we will be covering all parts of the Good Faith Estimate.

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Reader Comments

roland on March 28, 2007 at 6:30 pm

Regarding 2yr fixed rate with 3 yr prepayment penalty, I heard that in california there’s a law that you have 90 days to refinance your mortgage after 2 yrs. without penalty even though you have 3 yr prepayment penalty. Is this true?

Tom Voli on March 28, 2007 at 7:38 pm

I have not heard this. It is rare to have a 3 year prepayment penalty on a 2 year fixed rate loan. In fact, this is unethical and whoever sells a loan to a borrower with this type of prepayment penalty should be flogged. This forces the borrower into a year of rising payments with no way out except paying a penalty. I know it is done and I have seen them but I have never heard of a law allowing a borrower to refinance within 90 days after the 2 year period expires. I will check into it and if that is true I will make a post on that subject specifically. It is worthy of its own post.

Thanks for your input and I hope you are not in that position.

Ed Lathrop on April 6, 2007 at 11:39 am

Citicorp has a prepayment penalty on their 1st and 2nd mortgages or, at least, that’s what they told me last year when I was interested in refinancing. They told me they would wave the charge if I refinanced through them. My mortgage is 15 years old.

Tom Voli on April 6, 2007 at 7:47 pm

Something fishy here Ed. There is no prepayment penalty on a loan that you have had for 15 years. Unless this was refinanced within the last few pears that is incorrect. Give me a call at (949) 766 5054 and I will help you with this.

Michelle on May 4, 2007 at 10:16 am

Greetings…I had a loan office I had worked with for many years. There had never been anything regarding working with her that made me suspicious of the last time I refinanced my residence and two rental properties. I asked for a loan with no pre payment penalty and interest only. Rushed though a closing at my kitchen table assuming it was as I thought…no pre payment penalty and interest only payments…in realty I have the mortgage from hell. I have huge pre penalties on all the loans, nothing close to the verbal interest rate she quoted me and a negative amortization payment. Any thoughts?

Tom Voli on May 4, 2007 at 2:32 pm

This is the common MO for a sloppy loan officer or one who is desperate. The unfortunate thing is you trusted the loan officer and they let you down. There is not much you can do but I suggest you get out of the negam loan regardless of the prepay. The interest rate on those loans keeps going up and the rate of negative amortization can be more costly than the prepay. Call me at (949) 766 5054 if you’d like to know what is available.

Steve G on May 26, 2007 at 8:09 am

I have a 5 yr loan with a four pay plan. My interest only rate keeps going up with an adjustable. I think I have a hard pre pay penalty for 36 months which they’ve said I will have to pay the owed interest portion. Is their a way out for a better non-adjustable loan?

Tom Voli on May 26, 2007 at 11:34 am

Yes Steve. There are options available that can stop the adjustable rate yet still leave you with the 4 payment options, or you can change this into a standard 5 - 10 year fixed rate with no negative amortization. Call me at (949) 766 5054 to discuss options available.

Cecil Hicks on June 1, 2007 at 3:25 pm

Hello….I just wanted to to if my wife filled for bankruptcy in my 2005 and will be discharged in Aug 2007 for a fanny mae loan which applies to consider her for a good rate,,,,,,,,,from file date or disgharge date? My mid score is 587 and her score is 680 what should we expeect for a good intrest rate from brokers?

Tom Voli on June 11, 2007 at 10:08 am

The discharge date is what lenders use to determine aging of a BK.

As for rate based on credit scores this would depend on which of you is the primary income earner. A 587 score will not provide a good rate but a 680 is ok. Many lenders will provide a quote based on whoever’s score is lowest. Get that score up before making any moves to purchase.

Kathy Snyder on June 22, 2007 at 4:51 am

When we first took out our mortgage 3 years ago (settlement date) to date in August 23, paper signed…we have a 3 years prepayed penalty charge. We are looking into refinancing now with Countrywide…they claimed that as long as I don’t sign papers before July 1, 2007, that I will not have to worry about any prepaid penalty costs…are they being honest?

Tom Voli on June 22, 2007 at 5:29 am

If your settlement date was August 23rd then August 1st would be the cutoff …not July 1st. Unfortunately, many lender retail reps are very limited in their understanding of prepay enforcement.

Give me a call and I will be happy to make sure the rate, term, etc is what you deserve. (949) 290 - 1795.

Barron on June 27, 2007 at 1:32 am

I was fooled by my mortgage lender on my second mortgage and I signed for a 24-month full prepayment penalty in the amount equal to 20% of the outstanding principal balance. This is after I informed them that I had a house on the market, which could sell within months time, which it just did. I was told to contact them before I make a “full payment,” so I don’t understand why there was a prepayment penalty added. Anyway, there is probably nothing I could do about that. But my question is the 20% of the outstanding principal balance outrageous? Or am I just not understanding? I researched online and it seems that most offer prepayment penalties of 80% of 6 months of interest. Would I be better off to pay the penalty now or just hold the money until the 24-months are up? Please help.

Tom Voli on June 27, 2007 at 6:11 am

You may have this confused.

Typically they will not allow you to PAYOFF more than 20% per year. Doing so would initiate the prepayment penalty of 80% of 6 months interest.

Ty on July 7, 2007 at 12:56 pm

Help, I just re-financed my home about 6 months ago, and now I’m stuck with a 2yr pre-payment penalty. Is there a way that I can get out of it? My broker at that time was a family friend who I thought I can trust, but eventually he screwed me over without letting me know all the details. He told me that I will also get 2 months of deferred payment, and that didn’t happen either. Now i’m stuck with a 5yr fixed with a montly payment that I can’t even afford anymore. Thats not even including tax and insurance. Please Help!!

Tom Voli on July 9, 2007 at 10:12 am

Ty,

Unfortunately there is really nothing you can do to get put of the prepayment penalty. However, some lenders will waive this if you bring the loan back to them (not the loan broker…the lender). Call your mortgage holder and explain the situation and see if they have another product they would be willing to move you into.

If not it still may make sense to refi pout of your current loan into a loan morew affordable. This would require having some equity in the house. Call me at 949 766 5054 to review options available.

Bryan Biggs on July 25, 2007 at 5:30 pm

I am a competitor and am surprised you are not aware of California Civil Code Section 1916.5.5 that states, “The borrower is permitted to prepay the loan in whole or in part without a prepayment charge within 90 days of notification of any increase in the rate of interest.”

This is exactly the law that mortgage brokers send to the payoff department when refinancing loans that have a prepayment penalty that is longer than the fixed term of the loan. The payoff department must remove the prepayment penalty in this case or they are referred to the California State Attorney’s office for violation of California Civil Code.

Tom Voli on July 25, 2007 at 6:05 pm

This is great information Bryan. Thanks for sharing. I was not aware of that civil code.

todd on August 12, 2007 at 5:49 pm

i have a 3 yr pre-penalty on my mortgage with one year left. what happens if i have to refinace due to my income/business dropping because i can not afford the monster payment anymore?

Tom Voli on August 14, 2007 at 7:45 am

If you have to refinance prior to the prepayment penalty period expiring you will pay a prepayemnt penalty as per your contract. This usually equates to apx 80% of interest for a 6 month period.

Dominique on August 25, 2007 at 12:41 pm

Good Afternoon Tom:
The first two years of our loan was fixed. I have an adjustable loan and our payments are set to increase beginning September. Since my husband is being recalled into the military he will take a paycut. We have tried to refinance but are stuck with a penalty fee. The prepayment rider states “if more than 20% of the original principal amount of this note is prepaid in an 12-month period within 3 years after the date of this loan, I agree to a prepayment of six months interest…” Are we stuck? We closed in July 2005. Do we have to wait till July 2008 to avoid the penalty?

Tom Voli on August 25, 2007 at 12:48 pm

This can be refinanced without penalty.

As Brian Biggs quoted: Civil Code Section 1916.5.5 that states, �The borrower is permitted to prepay the loan in whole or in part without a prepayment charge within 90 days of notification of any increase in the rate of interest.�

Anurag Naik on December 6, 2007 at 5:32 pm

We purchased our condo in March 2006, have two loans, both are IO loans, so we have not built any equity yet. Our monthly payments are $2700, not including taxes, HOA and insurance. We want to re-finance, but not sure if we can, since we have a 3yr Pre-payment penalty. Please help.

Wendy on December 7, 2007 at 9:45 am

I have been working w/ Accredited Home Lenders on tryingt to get a prepay waived, the loan was originated by Home Funds Direct. I was put into a 2 year ARM and a prepayment penalty that lasts 6 month’s after the adjustment. I was wondering if you might have any info on this type of situation?

Tom Voli on December 12, 2007 at 9:26 am

They MUST remove that prepayment penalty if it extends past the first adjustment period. They can not lawfully require you to hold that loan if you want out of it.

Unfortunately, these lenders employ various levels of $8 - $12 per hour employees that have no authority to get this done for you. You need to ask for a manager…several times….till you get the 1 that can get things done.

If that fails you may need to hire an attorney. There is no way you should have to pay a prepayment penalty.

Tom Voli on December 12, 2007 at 9:28 am

Anurag,

You will need to have cash in hand to refinance. You are probably in a negative equity position and will not be able to refinance easily.

Young on December 28, 2007 at 4:49 pm

I have a 3 yr.prepayment penalty on my mortgage(30yr.fix.) with 8 months left. I need to refinace now due to my high debt. I’ve read recently that the Federal Reserve Board proposed the rule which would be adopted under HOEPA on Dec.18,2007.; Prepayment penalties would only be permitted if certain conditions are met, including the condition that no penalty will apply for at least sixty days before any possible payment increase.
I don’t get it clearly. Does that rule effect on my case?
Is there no way to avoid pay penalty fee,if I refinance right now? Is there any chance to negotiate ? Thanks in advance!

Tom Voli on December 28, 2007 at 5:22 pm

The prepayment penalty will still be in effect till that 60 days prior to the 1st adjustment.

KAREN on January 4, 2008 at 8:29 am

I am unsure at this time what my PrePaid Penalties are for my currant Mortgage. I have a 3 yr Adjustable and My rate is now going up and I am Refinancing. My question is, will I be due back any money when I from my currant Mortgage Co.? Is this considered paying off my loan to early if it is adjustable?. I am new at understanding this Pre-paid Penalties and do not know what I can do. My new Mortgage Co I have locked in with are putting on the PPP. Please give me some advise.
Thank you Karen

Tom Voli on January 4, 2008 at 8:51 am

Karen,

If you have a 3 year ARM (meaning, it was fixed rate for 3 years and is now converting to adjustable) you have the right to refinance that loan within 60 days of the first expected rate adjustment WITHOUT a prepayment penalty. Some lender try and get away with this but an experienced loan professional can force the issue.

As for your new loan, there are many very good programs available with NO prepayment penalties.

Feel free to give me a call at (949) 766 5054 and I will cover some of this with you.

donna bryan on January 20, 2008 at 10:20 am

I have very bad credit. I am not looking for a miracle. Our mortgage was with Nova Star Mortgage. Nova Star sold our mortgage to Saxon. My husband lost his job and this caused us to have to move to another state. To my knowledge, I never received notice of this transfer. I did call Nova Star and speak to them, as my payment was late. They did tell me that our loan had been sold to Saxon. I called Saxon repeatedly and they kept telling me the sell was still in process and they had no information on our loan. Our loan is only 1 yr. and 8 mths. old. We have found a buyer. Saxon now tells us that we will be paying $13,390.44 in late fees and payoff penalties. Our actual loan payoff is $ 133,999.55. We are only asking

donna bryan on January 20, 2008 at 10:31 am

We have had our mortgage loan for 1 yr. and 8 mths.. In August of 2007, my husband lost his job of 8 years. Our loan was with Nova Star Mortgage. Due to unemployment, of course, my payments were way behing. I called Nova Star and they told me they had sold our mortgage to Saxon. I called Saxon and they said they had no information, since the sell was so new, they had to get all the information from Nova Star. We have now found a buyer. We have agreed to sell for $ 150,000. It took 3 weeks for me to get the payoff amount from Saxon. I wish I hadn’t asked. The actual payoff is $ 133,999.55, but they have added $ 13,390.44 in late fees and pre-payment penalties. So they want $ 147,389.99. We also owe back taxes of $ 3, 966.43. I know that I got myself into this mess, but are any of these fees negotiable? Please help! The buyers are anxious. We only received the payoff amount yesterday.

ShereeDavidson on January 20, 2008 at 12:47 pm

I settled for a mortgage which I now know that I should not have. I am now thinking about refiancing with another company but the old loan has a prepayment penalty. If I pay off the old mortgage with the new mortgage before the effective date that my prepaid penaltly will start (starting the 1st thru 36th months) would I still have to pay the fee. The effective date was starting the 1st month and not the date the loan was made.

Wendy on February 4, 2008 at 9:06 pm

Dear Tom,
Thank you for your response to my question on December 12th.

I am still fighting this with Accredited Home Lenders about the prepayment penalty. I am in a 2 year ARM that is set to adjust September 08. The prepay expires 6 months after the 1st adjustment. I am currently working with another company to secure an FHA loan. Accredited finally after weeks of arguing back and forth agreed to drop it by 4k. The original prepayment was 9600.00 You stated that I would have to get an attorney, where should I go for that. Accredited is holding to their guns that I signed the prepay rider during closing, but truthfully my broker never explained it to me. I just want this over with so I can move on. I am able to get the financing, it’s the pre-pay that is doing me in. I know you say it is unlawful for them to do this, I just don’t know where else to start. I really need all of it waived. Any advice would be appreciated.

Gina on February 6, 2008 at 10:56 am

Hi -

We have a mortgage with a real problem. We signed in October 2005 with a two year prepay penalty. Our mort company - NEW CENTURY turned over our loan to another servicing company right before they fell off the face of the lending earth. Problem is that the new servicer has what I believe to be a fraudulent document stating there is a 3 year prepay penalty. I have sent them the copy we have of the original document and they refuse to accept as it is not the original. So, according to them, I still have 8 months before I can get past the prepay clause and my payoff to refinance now is $6K higher than the original loan amount. Something is just so wrong with this.

Karen Moody on February 24, 2008 at 11:41 am

My credit score has gone down since I purchased my home 1.5 years ago due to some high credit card balances which I plan to pay off but my high mtg is eating that intention away. There is a 2 yr pre-pay penalty on my mtg which I intend to refinance and wonder how will my current credit affect the refinancing process. I do need someone experienced with the current policies regarding refiancing as my mortgage company is no longer doing refinancing…they are going bankrupt.

Angela on April 15, 2008 at 3:25 pm

Hi! We are looking for relief at our 2 year fixed, with a 3yr Pre-pay penalty. I found this is the documents:
I am a little confused

California Civil code 1916.5.5 and .8
States

The borrower is permitted to prepay the loan in whole or in
part without a prepayment charge at any time, and no fee or other
charge may be required by the lender of the borrower as a result of
any change in the interest rate or the exercise of any option or
election extended to the borrower pursuant to this section.

Am I reading this correctly? Can we get out with no penalty?

cathy on April 20, 2008 at 9:17 pm

We took out our loan on Oct.,2006. It is a 2 year ARM, with a prepayment penalty charge if the loan is paid off sooner then 36 months. We are now in the adjustable stage but not out of the prepayment penalty stage. Is this legal? We are trying to sell our home and we may before the 36 months is up. Should we still get charged the fee?
Thanks for your time.

Kate on April 22, 2008 at 12:27 pm

We are selling our house b/c my husband is active duty and has received orders to move out of state. I received my payoff statement and it had a hefty prepayment charge. I was under the impression that if the military orders you to move that they must/can wave the prepayment. Also the prepayment period will end approximately 45 days after the sale of our house. Could this help negotiate waving the prepayment if needed?

Nick Ducas on April 29, 2008 at 4:26 am

30 year fixed rate and a pp of 5 years in excess of 20%.Is there a less expensive way to overide it? This company has bought my mortgage and seems this company according to people that have commented is the mortgage company from hell. The first mortgage company let me pay $60K toward the loan in the first year with no penalty…Then this mortgage company sold the contract…It is 4 years old…Any ideas?

Nick Ducas

Ken on May 4, 2008 at 4:02 pm

I’ve got a 3-year pre-payment penalty and am selling my home about 9-months early due to military PCS orders. I know that under any other circumstance I’d be required to pay the pre-payment penalty of 6 months advance interest…however, considering that I’m forced to move due to military PCS orders, can the Pre-payment penalty be waived? Maybe this is covered under the Servicemembers relief act or some other Civil Code that I’ve missed in my research?

TRUDY on May 15, 2008 at 9:52 pm

Is it legal to have a prepay penalty for the entire life of the loan?