I love attending closings with first time home buyers - their joy is very contagious and uplifting! But this euphoria can be cut short if the homeowner has to sell in less than threeto five years due to job transfer, medical problem, or other reasons.
If the seller is lucky, home prices rose enough to cover the listing commission. The bigger problem comes in to play, however, when the seller calls the mortgage company about the payoff. Though he or she might have been diligently paying a little extra each month toward the principal balance of the loan, a prepayment penalty can sneak in and clobber the seller. Depending on their loan, a seller could face a prepayment penalty ranging from $800 (the lowest I’ve seen) to $17,000 (the highest I’ve seen).
According to Free Advice, the prepayment penalty is there to protect the lender:
From a mortgage lender’s perspective a prepayment penalty helps the lender at least recoup some or all of the significant expense it incurs in putting a new loan on the books. If the loan is to be repaid quickly, such as if you refinance it elsewhere, the lender can incur a loss, as it has not had time to make up the costs it advanced.
I found the article in the Wall Street Journal, The Unpleasant Surprise of Prepayment Penalties, to be very interesting. It said (near the end) that sometimes lenders will waive the penalties, but only in very rare circumstances.
But smart buyers will shop around for great mortgage rates and terms. Gina at Gina & Neil’s First House explained that Neil made sure their mortgage product did not include a prepayment penalty. I bow down before their efforts to do their homework - making sure they asked all the right questions and shopped until they were comfortable with their loan product.
One caveat: If you do shop your mortgage, try to keep the inquiries within a 10 day window because if you stray from that it could impact your credit score.
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I am surprised at how often I hear often of borrowers being "surprised" by prepayment penalties (PPP's) on their mortgage loans.
How can a borrower be surprised when, as is universally the case in my experience, the borrower signs at least two or three or as many as seven or eight documents at closing on the loan that describe in detail that there may be a PPP, when it can occur, how it is calculated, and when it drops off of the loan. The Note or an addendum to the Note, the Truth in Lending Disclosure (required for all home loans), and usually more than than, all of which the borrower must sign, all detail the existence and terms of a PPP on a loan. Where is the surprise?
Only the careless, or certainly in rare cases the duped, will be surprised by a PPP or any other feature of a loan. If one was duped, then go after them, but if one is just careless, then there is no one to blame but one's self. You should not be angry with the car that hits you if you wander in to the street without looking both ways first.
Borrowers, read your docs and be careful who you borrow from, and there will be no such surprises.
Posted by: aaron | April 22nd, 2008 2:57 pm |