Prepays

By "prepays", I'm referring to prepay penalties.  What is a prepay penalty?  It is a fee paid by borrowers for the privilege of retiring a loan early.  There are borrowers who have them and are not aware that they do.   In the past, "A paper" loans rarely had prepays, but now they’ve become more common place; sub-primes, almost always have them.

HARD VS. SOFT

There are two varieties of prepay—the HARD and the SOFT.  The latter ALLOWS A BORROWER TO SELL THEIR PROPERTY while the prepay term is in effect and PAY OFF THEIR LOAN WITH NO PENALTY--just not refinance.  With a HARD PREPAY, IF YOU SELL OR RE-FINANCE BEFORE THE PENALTY EXPIRES YOU ARE REQUIRED TO USUALLY PAY 6 MONTHS WORTH OF INTEREST (because there is so little principal reduction in the early years of a loan this usually amounts to 6 months worth of mortgage payments).  Some penalty amounts are "stepped down" between years one, two, and three.

DURATION

Prepays can last ANYWHERE FROM 4 MONTHS TO 5 YEARS in length.  The lengths differ with different lenders and different loan programs.  In some cases, lenders will allow a borrower to buy their way out of prepay penalties.

Typically, I ask borrowers for copies of their mortgage notes because it's better for borrower and broker to find out upfront if there is one before the borrower pays for an appraisal while the broker has spent two weeks working on a loan only to find out that re-financing is not economically practicable at this time.  Some sub-prime lenders are notorious for burying these little surprises, not in the terms of the mortgage notes, but in addendums or riders to the note.

WHY

Having said all this, why would anyone agree to having one?  Because WITH A PREPAY THE RATE MAY BE HALF TO A FULL PERCENT CHEAPER OR IT MAY MEAN NO LOAN ORIGINATION FEE (since the broker’s origination fee is being covered by a rebate).  Moreover, having one may be a non-event in that it often has no impact on a borrower because they may have no interest in selling or refinancing their home during the term of the prepay.

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