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Mortgage Prepayment Penalties -- (PPP)

By
Mortgage and Lending with Social Media - Infinity Home Mortgage Company, Inc

money

Prepayment penalties sound like a terrible word and a waste of money. Yes and no. No?  What do you mean no. There are many different types of prepayment penalties on mortgages and many reasons why this takes place. You need to start with a knowledgeable loan officer that will explain this to you.

Why are there prepayment penalties on some loans? It's usually because you either have bad credit which would put you into the subprime market or because you can't prove your income (Alt-A loans) and are placed into some sort of stated program. Why does this matter to you? Generally people should improve their credit situation and credit scores over time. Or if they can show their income, they might be able to do this in a few years or build more equity in 2 to 4 years which will allow them to refinance into a lower rate.

Since you might improve over time, there is a good chance that you would be able to refinance in a shorter period. This is not always the case, depending on the market, such as housing values. But the lender is risking their money to make some sort of profit in a certain time frame. Generally they would need to hold onto your loan for 8 to 10 years for this to happen, making money on your interest. Considering that is a long time, this is the reason for prepayment penalties on these types of mortgages. It comes down to the risk factor and the risk the investor took in the beginning to lend you money.

 

Let's explore which loans might have a a prepayment penalty. Keep in mind, every state is different. Some states allow for prepayment penalties and some don't allow for this. 

What loans don't have these prepayment penalties :

  • FHA, Conventional (FNMA/FHLMC), and VA loans
  • Some Alt-A programs (sometimes built into the rate)


What loans do have prepayment penalties
:

  • Some Alt-A programs
  • Subprime loans in those states that this is allowed in. If not, the prepayment will be built into the rate.



Your typical prepayment penalty is usually 6 months of interest of the remaining principal balance. For a quick estimate, you can just multiply your monthly payment by 5. For a more accurate account of your penalty, multiply your interest rate to your balance of the mortgage.  Then take that number and divide it by 365. This will give you your daily interest. Then multiply this number by 30 days. This is your interest for 1 month. Then multiply it by 6 and this will give you your penalty for a 6 month period.

Example :

         $320,000 balance x 8.00% interest rate =  25,600     Then 25,600 divided by 365 = $70.14 

         Then multiply $70.14 by 30 days = $2,104.20 per month   Then multiply this by 6 =  $12,625.20

$12,625.20 is your penalty.  It's up to the loan officer to give you your options. In most cases, there are options, but sometimes the lender can't make YSP (yield spread premium) on your rate if you don't choose a prepayment penalty.  That means all of the money that they make on you has to be in regards to upfront points and fees.

 

Prepayment terms to pay attention to :

  • Hard prepay : Typically for 2 yrs, 3 yrs, or 5 yrs. This means that you can't sell your house or refinance during these terms. If you do, then there is a prepayment, usually 6 months interest. Some states vary.
  • Soft prepay  : This means that you can't refinance, but if you sell your home during this time, there won't be any type of prepayment penalty. These are usually the same length of time as a hard pay penalty.





Conclusion on what's better : It all comes down to exploring your options, knowing your goals, and to see whether or not which option might make sense for you. And the other type of penalty could be 2% of your principal balance. Depending on the lender and the state. Speak to a trusted Mortgage Consultant who can explain this too you and not just say "because".

 

Just a side note, I was inspired to write this after a comment that Missy Caulk left me in this post, Mortgage Rates -- Locking or Floating -- Part 2 of 2

 

 

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Copyright © 2011 by Jeff Belonger of Infinity Home Mortgage Company, Inc

Joe Adams
Major Mortgage USA/Branch Manager - Montrose, CO
I have been getting a ton of questions about PPP the last 2 months and that is wonderful because I am doing so much with FHA that it is easy to blow the other LO out of the water.  PPP are a scary thing for a lot of people, but some times it makes sense for the borrower, if you can get a slightly better rate with a 3 year soft PPP and you intend to be in the home for longer than that 3 year period. As for Option One, I will be watching them but they are not competitive yet in this market and it isn't even close
Aug 25, 2007 05:42 AM
Susie Roscoe
Signature Realty Associates - Brandon, FL
Real Estate Specialist | Brandon, FL

There's alot of good information here.  I am "for" the soft prepayment but not thrilled about the rules on hard prepayment.  Too bad "we" don't always get to choose! 

Aug 25, 2007 05:49 AM
Jeff Belonger
Social Media - Infinity Home Mortgage Company, Inc - Cherry Hill, NJ
The FHA Expert - FHA Loans - FHA mortgages - USDA loans - VA Loans

Sean & Pilar......   thank you very much.  This post should clear the air for some.

Tom W. ..... not a problem, my pleasure. Option One has their niche, but it isn't Alt-A at this time. They are new players in this type of market. 

Jason.....  as stated, yes, there are a few more outside the 6 month prepayment penalty, which I mentioned. But the 6 month interest penalty is your most used penalty. As we have both stated, working with a professional that will make you aware of this is crucial and important.  And thanks for the compliments.

Joe..... well, FHA should be hands down, because of the buyers that are out there. Many with some credit dings and little or no money. There is so much that you can do with FHA, as long as you can prove your income. Thanks for stopping by and for your feedback.

Susie.... Soft prepay or hard prepay... it still comes down to that clients goals. Some people actually know that they will stay in a house for a long time, possibly 10 years. Depends if they have young children, know the housing market, might add an addition... if so, then the hard prepay will be the cheapest. Thanks for the compliment.

Aug 25, 2007 06:35 AM
Seth Callen
Farmers Insurance - Lawton, OK
Informative post.   In some rare cases, I've had borrowers who've been able to use the PPP to their advantage by getting some basis points knocked off for accepting the 2 yr PPP when they are CERTAIN they will be in the house past the PPP period.  
Aug 25, 2007 06:44 AM
Celeste "SALLY" Cheeseman
Liberty Homes - Mililani, HI
(RA) AHWD CRS ePRO OAHU HAWAII REAL ESTATE

Pre payment penalty ....I've had client's who had 80/20's and sold but had to because they were deploying. It was three months interest. Do they vary?

Aug 25, 2007 06:53 AM
Randy L. Prothero
eXp Realty - Hollister, MO
Missouri REALTOR, (808) 384-5645
I have a client right now that got is orders to ship out in the Navy.  When he bought a year and a half ago he had good credit and was VA eligible.  The mortgage broker he worked with stuck him with a hard pre-pay.  He is now  faced with a stiff penalty if he sells before the 2 year mark.  No excuse for that at all.
Aug 25, 2007 07:07 AM
Missy Caulk
Missy Caulk TEAM - Ann Arbor, MI
Savvy Realtor - Ann Arbor Real Estate

Well, Jeff you could have told me I had a misspelled word in my comment. LOL

This is helpful information. I don't like them anytime, because you never know. I have had some loan officers say that if they re-finance with their company there is no penality.

Aug 25, 2007 07:17 AM
Kim Murphy
Draper and Kramer - Lombard, IL
Mortgage Loans in DuPage, Kane, Cook, Lake, Will C
Jeff - PPP are not the norm in Illinois, but were several years ago.  All sub-prime had them.  The only PPP I can think of currently is with Option Arms is YSP is over 1% (I believe)  If I am remembering correctly on federally chartered banks can issue a PPP in Illinois. 
Aug 25, 2007 07:23 AM
1SG (Ret.) David Kucic
Hawaii Military Realty, Inc. - Ewa Beach, HI
President and Owner
That was a real eye opener Jeff.  I am again thankful that I work with mostly VA borrowers who dont have to worry about the pre-payment penalties.  The example you gave was a pretty big number and would be significantly higher here in Hawaii.  Ouch!
Aug 25, 2007 07:26 AM
Tom Burris
NMLS# 335055 - Baton Rouge, LA
Texas/Louisiana Mortgage Pro - 13 YRS Experience

I always liked the comment: "I got STUCK with a PPP"

Uh, you have a choice. If you don't like the terms, don't buy. People with good credit have options!!!

Aug 25, 2007 07:39 AM
Jeff Belonger
Social Media - Infinity Home Mortgage Company, Inc - Cherry Hill, NJ
The FHA Expert - FHA Loans - FHA mortgages - USDA loans - VA Loans

Seth...  yes, as I have stated, sometimes a PPP can be beneficial for you. Goals are so key. Thanks for the compliment.

Sally.....  this one I am not familiar with. A prepay on a 80/20, unless it was a subprime deal. Subprime deals could have some prepays, even on a 80/20.  But 3 months interest?  Never heard of that one.

Randy.... if the client was never told, that loan officer knew. What a crook....  sure, the borrower signed a document at closing. Sure, the clients should at least read all subject lines of each document. Yes, most clients don't read all documents, but read the subject line at the top. It would have said prepayment. Overall, it does suck.

Missy..... you misspelled a word in your comment?  What word and when?  Sorry, I didn't notice. 

In any case, in some instances, they just can't be avoided, depending on the type of program. And in regards to the loan officers that make those kind of promises are the ones that give us a bad name. But I blame the consumer also. The consumer should ask for this in writing. PROOF. 

Kim.... yes, federally charted banks can basically charge what they want, when they won't. And most lenders that offer the pay options arms are federally charted.  Overall, I am not familiar with

David....  Yes, that does seem high. But again, people have to remember that just because you have a prepayment penalty, doesn't mean that it's very bad. Again, it depends on what you are trying to accomplish and what your goals are. Thanks for stopping by.

Tom.... I agree, you have options. But admit it, there are many loan officers that either don't give you these options or don't tell you that you have a PPP. Or.... they make it sound like this is your only option. I hear about this often. 

Aug 25, 2007 07:50 AM
Gareth Bourriague
Benchmark Mortgage of Louisiana - Baton Rouge, LA
Benchmark Mortgage
Great info as always Jeff!  I haven't seen it broken down like that...ever.  =)
Aug 25, 2007 08:54 AM
Desiree Daniels
RE/MAX Tri County - Robbinsville, NJ
I had a friend who's place I sold recently that at closing got hit with a $6000+ pre-payment penalty on a mortgage she had refinanced a couple years earlier........   and this was a FRIEND of hers.    I use that term loosely.    She learned the hard way.....  Always ask if there's a pre-payment penalty.... never know what or when something could change in your life
Aug 25, 2007 01:46 PM
Kris Wales
Keller Williams Realty - Lakeside Market Center - Macomb, MI
Real Estate Blog & Homes for Sale search site, Macomb County MI
I am familiar with pre-payment penalties, but had no idea there were "hard and soft" penalties and the differences between them.  Again, I learn something new from you with every post.  Thanks.
Aug 25, 2007 10:06 PM
Matthew J Blum - (retired from the business)
Palm Beach Gardens, FL
Jeff, Great post. Nice way of explaining it. In Florida it is legal for a pre payment penality.  The only thing people have to watch for is when the loan officer has a penality pass the fix period.  I have seen this before and I am always shocked.
Aug 25, 2007 11:01 PM
Gita Bantwal
RE/MAX Centre Realtors - Warwick, PA
REALTOR,ABR,CRS,SRES,GRI - Bucks County & Philadel
Thanks for a great post. I have come across people who have PPP but did not know there were hard and soft penalties.I will bookmark this post.
Aug 25, 2007 11:25 PM
Jeff Belonger
Social Media - Infinity Home Mortgage Company, Inc - Cherry Hill, NJ
The FHA Expert - FHA Loans - FHA mortgages - USDA loans - VA Loans

Gareth....  well, thank you very much for the kind words and for the comment.

Desiree.... well, until I knew what her circumstance was, I can't say if it was right or wrong. But what definitely sounds wrong is that she was never told about it. That's sooooo wrong. But as I stated, sometimes they can't be avoided, depending on your credit or income. But it should be brought to your attention and why.

Kris.....  you might be surprised on how many loan officers don't even know the differences.  Thanks for the kind words.

Matthew..... I know about the lending laws in Florida. It's just sad that so many don't explain this and the client doesn't find out until they are ready to refinance or when they sell their home.SAD.  That's why you and I.... and so many others need to educate. Thanks for the polite compliment.

Gita...... I just love educating and sharing what I know. Thanks for the compliment.

Aug 26, 2007 02:21 AM
Arlyn Mendoza
HomeServices Lending LLC - South Miami, FL

Hi Jeff,  Good Post! I have a customer right now in a refinance that didn't know he had a penalty. His loan is wih CW. Poor Guy, I had to give him the bad news that his cash out ws going to be almost $6K less b/cause of it... Most of the PPP's that I have seen and have closed are 3/2/1 PPP's... I know that Wells Fargo will waive the penalty on a refinance if they are doing the new loan, in most cases.

I simply don't understand how a borrower can say that they didn't know they had a prepayment penalty!!!  Even if they didn't get the information from the lender, they received disclosures( usually twice!) and the closing agent should have also explained it!!!  I just don't understand how someone can sit at a table , pen in hand , and not question everything they sign!  Sometimes you just can't help some people you know. there has to some personal responsibility !

anyway,, Enjoyed reading this, Good Job!

 

Aug 26, 2007 11:33 AM
Mitchell J Hall
Manhattan, NY
Lic Associate RE Broker - Manhattan & Brooklyn

Hi Jeff,

Great information. My building has an underlying mortgage with a pre-payment penalty of about a million dollars. The developer of my building had an underlying mortgage with a $15 million dollar baloon payment that was due 10 years from the time the building was built which would have been due in 1998.

My building's board is made up of pretty smart people (attorneys and accountants) we refinanced to a fixed rate at 8% back in the 90's but got stuck with the pre-payment penalty. Our maintenance had to be increased because of it. I think it was a bad decision because we are stuck at 8% and can't refinance.

Aug 28, 2007 02:20 AM
Tony Gallegos
Cognicorp Mortgage Banking Advisory - Marietta, GA
Jeff - I have the solution...everyone should do more FHA and VA loans! Do you know anyone who knows how to do them? LOL. Thanks for the great articles and post you are writing about.
Aug 30, 2007 02:20 PM