Prepayment Penalties: Foul or Fair?

February 18, 2007 by 12 Comments

Mpj040179500001A prepayment penalty is a fine charged to a borrower if they payoff their mortgage before a certain time period (typically 2-3 years).   The fine is commonly 6 months interest (just shy of six months mortgage payments less your monthly taxes and insurance) and may vary.   

Most often, the prepayment penalty is "hard", meaning that it will be assessed whether someone is refinancing or selling their home prior to the time period being met.   Sometimes, the prepay may be a "soft" penalty and is forgiven in the case of a person selling their home, but charged if the borrower is refinancing.

For example, on a $200,000 loan amount with 6% interest, a prepayment penalty based on 6 months interest would be $6,000.  It’s expensive.   It may be a tax deduction since it is prepaid mortgage interest, however, if you’re paying if off for a refinance, it is also taking away home equity.

Some times, prepayment penalties are required for the certain mortgage program.  This is most often the case with subprime mortgages.   This has potential to cause a dicey situation if a subprime borrower has 100% financing, like an 80/20 with an adjustable rate mortgage, and the borrower does not work on improving their credit before the prepayment is over and the ARM adjust.   Subprime loans are becoming tougher to qualify for and  some subprime lenders have closed their doors.

If the borrower has good credit and equity or a down payment, then the prepayment penalty should be optional and the borrower’s choice.   The prepayment penalty may be used to lower the mortgage interest rate.  If this is the case, the Loan Originator should show the borrower the difference between the two rates and payments and fully explain the terms of the prepay.    If the "a paper" borrower is not receiving the benefit of the choice between having or not having a prepayment penalty, then it could very well be lining the pockets of the loan originator.    If your loan originator is telling you that you must have a prepayment penalty, and you have great credit PLEASE GET A SECOND OPINION.

Prepayment penalties need to be disclosed to the borrower up front.  This should not be a surprise to a borrower at signing.   Review your Federal Truth in Lending statement that accompanies your Good Faith Estimate.   There will be a sentence with a box stating:

Prepayment:  If you pay off your loan early, you  ( X ) may (   ) will not  have to pay a penalty.   

If the "may" box is checked, you have a prepayment penalty on the proposed loan scenario.   If the loan originator did not disclose this to you upfront, contact them to find out if and why there is a penalty.

The Good Faith Estimate and Federal Truth in Lending are required to be provided to you from the loan originator within 3 days of providing you a rate quote.   At signing, you will also receive a disclosure regarding the prepayment penalty.

Whenever a prepayment penalty is optional, even if it is to lower a borrower’s interest rate, I am opposed to them.  You never know when life will happen and you need to sell your home or if mortgage interest rates improve and you want to take advantage of the lower rate.    With some programs, such as subprime loans, the prepayment penalty may be required.   If this is your scenario, ask the loan originator if the prepayment penalty can be "cashed out" or reduced upfront. 

Regardless of your situation, your loan originator should fully explain all of your options to you.   Should you decide to obtain a second opinion from a Mortgage Planner, simple provide them with your credit scores, loan-to-value (sales price or value of the home and the loan amount), documentation (is it easy to document your income and assets or do you need a no-income verifier type of loan), and program type.   You may also consider providing the lender with a copy of your good faith estimate to review from the first loan originator.  The lender who provides you a second opinion should not  have to re-pull your credit at this stage.

It’s your money, your assets, your home and your responsibility to make sure you understand (ask questions…don’t be shy) your mortgage scenario.    Prepayment penalties are fair IF you understand how and why you have one with your mortgage.  If it’s helping someone with an iffy credit past (assuming the new home owner is now responsible with their credit, debts and cash flow) become a home owner, then I’m all for it.   If it’s to increase the commission of a loan originator, it’s FOUL.

Filed Under: Mortgage, Predatory Lending, Refinance, Residential Purchase, Subprime Lending

Why Is My Payoff Higher Than The Principal Balance?

February 12, 2007 by 2 Comments

Mpj040096800001I am often asked this question during a refinance from homeowners.   Your mortgage payment is paid in arrears.   For example, your February payment is paying January’s interest.   Remember when you bought or refinanced your home and the loan originator stated “you’re going to skip one month’s payment” or “you won’t have another payment due until the following month after closing”?  Well this is where that payment essentially catches up with you.  (Technically, it’s not “that” payment, you’re just always paying the previous month’s interest).

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Filed Under: Escrow and closing, Mortgage, Refinance Tagged With: , , ,

Can I Pay My Own Taxes & Insurance?

February 8, 2007 by 1 Comment

Mpj034188500001Unless you have 20% or more of equity in your home, chances are you have an escrow account (also referred to impounds or reserves) for your home owners insurance and property taxes.   Lenders want to make sure that they reduce risk by requiring taxes and insurance to be included in your monthly mortgage payment.  Property taxes are one of the few items that can take precedence over lien position in the event they were to not be paid.   Your first mortgage wants to stay just that, a first mortgage (in the event of a worse case scenario, foreclosure).

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Filed Under: Mortgage, Refinance, Residential Purchase Tagged With: , , ,

What is Escrow?

February 2, 2007 by Leave a Comment

Mpj042214800001_1One of the first-time home buyers I’m currently working with just called me with a few excellent questions.  She and her boyfriend have recently made an offer on their next home, with their agent which was accepted.  They now have handsome stack of papers from the escrow company (as if the paperwork from the lender wasn’t enough) that caused some questions.

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Filed Under: Escrow and closing, Mortgage, Refinance, Residential Purchase Tagged With: , ,

Before You Go to Your Signing Appointment

January 27, 2007 by 5 Comments

EDITOR’S NOTE: This post has been updated. Click here to read the most current version.

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1.  Bring a cashier’s check.  A good lender will do everything in their power to provide escrow with instructions in a timely manner so that they can, in turn, give you the dollar amount required as soon as possible.  Sometimes, you may only get a day or two of notice before escrow contacts you with this information.   The reason this can occur so late in the process is because all the loan documents have to be prepared by the lender and are then delivered to the escrow company with our instructions.   The escrow company then creates a HUD-1 Settlement Statement which determines exactly how much funds you need to bring to closing.    When you are told the amount, you need to obtain a cashier’s check payable to the escrow company and bring it with you to the closing appointment.   A personal check is a no-no.  NOTE:  If you are considering wiring funds to the escrow company, please contact them in advance to discuss this process.

2.  Bring a copy of your Good Faith Estimate.   You will want to compare it to the Estimated HUD-1 Settlement Statement that will be presented to you at the signing.   Hopefully, the Escrow Officer has provided your Loan Originator a copy of the HUD in advance for them to review it prior to your appointment.   

3.  Bring your current driver’s license.  The notary must see them for proof you are you!  Some may require two forms of identity.

4.  Bring anything else that the escrow company or lender request.  Sometimes the lender may need you to bring follow up documentation to closing (such as originals, paystubs, etc.). 

5.  Bring directions to the escrow company.   Be sure to get specific directions to the escrow company from the escrow company (or visit www.mapquest.com).  Please be on time.  Escrow companies are often very busy and generally on time.

6.  Plan on your signing taking approximately 45 – 60 minutes.  If you would like to have more time to read your documents, or to have an attorney review them for you, ask your lender in advance so they can accommodate having a copy of your loan documents available to you in advance.   Your loan package is about an inch of paper.   If you want to read it word for word, you should get a copy beforehand.   

7.   Sign your documents as your names appear.   Sign your name within the County’s required borders for recordings.  This avoids last minute corrections or delays in your closing.   You may want to do some hand exercises before signing (just teasing—well, kind of).

If you have questions regarding your loan documents or program, please call your Loan Originator.  Don’t be shy!   The signer may not be familiar with your specific loan program.

After signing your documents, escrow sends the original required documents to the title company who, after reviewing, delivers them to the County.   With our company, the funding department also reviews the loan documents and verifies all conditions are met. 

At this point, the lender coordinates with the escrow company to release the funds and to record the documents on the scheduled day for closing.   Typically either the escrow company or your real estate agent will contact you once your transaction has recorded.

Filed Under: Escrow and closing, Mortgage, Refinance, Residential Purchase
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