Avoid Paying Prepayment PenaltiesAvoid Paying Prepayment Penalties

Prepayment penalty loans are on the rise, which means mostly everyone who is buying or refinancing their loan with high loan to value or a maximum 100% financing will be required to take a prepayment penalty. Conventional lenders usually don't require borrowers to have a penalty. Mostly, these loans are investor loans, direct lender loans, and portfolio lenders that either offer low adjustable rates or qualifies borrowers with minimal documentation. 100% (no money down) loans are usually attached with a prepayment penalty.

How to avoid mortgage prepayment penalties: always remember to ask for an option not to have it. The lender will then buy down the prepayment option by increasing your rates or your fees. Some lenders offer no prepay penalties for 100% financing if your credit meets their minimum required scores and if you can provide income documentation to fully qualify for your loans. No income, stated income, or no ratio loans typically will have a prepayment penalty.

It is very important for you to take this seriously. The penalty will play a huge factor when you want to sell or refinance your loan. When the market is going up in value and prices are rising to the tune of 20-30% per annum. Nobody thinks anything about these penalties, its invisible as far as some people are concern. But keep in mind that the prepayment penalty will cut into your future net proceeds when you sell your house. It will decrease the amount you can take out on a refinancing loan in good or bad times and the most important factor is if the property value starts to see earth you might not be able to do both, especially if you had bought your property this year and it has not appreciated as much. Mostly, all the analyst agree on one thing: all these aggressive loans that carry an interest only payment or an option loan (negative amortization) payment normally carries a prepayment penalty. That might be the most valid reason why properties will go into foreclosures and default.

Lenders are starting to have more stringent guidelines for loans that have a negative amortization feature. This means the principal balance on your loan will actually go higher each month if you choose the option that requires the minimum payment.

How can you request for the prepayment penalty to be waived by lenders?

This gets pretty tricky--and it's actually something I have not done too much--but I always suggest it, because the reward could be very much worth the effort. Recently, we have been asking lenders to forgive the prepayment penalty portion of the loan if we were refinancing our clients' loans. We have only been successful twice and it's much less effort for us and the escrow company. I believe it's pure luck because the lender actually can show you proof that you agreed to a penalty if you were to payoff the loan prior to its due date. But I would like to share something with you that might be very helpful to some readers.

If you are in a situation where you have to refinance or sell your house prior to the penalty term due to hardship, some lenders will require you to prove that you are actually in that state and cant continue further to pay your loan. Hardship comes in many forms: you have too much debt and can't make the payments due to your current income status, property values have not gone up as much as you have thought they would and you have to payoff the loan, or maybe you have lost your job or gone on a disability status where you income has decreased. The lender will evaluate your whole situation and look into your complete financials and decide whether you qualify for the prepayment penalty to be waived.

If you are to sell your property it works a little differently. They will ask for listing agreements and they want to see some comps to justify why you are selling your house for a certain amount. You could also list things that needed to be repaired to the house, or other defects if there are any. A full disclosure of all costs of the sale will be required to show the lender that the net proceeds will come to a negative with the prepayment penalty in there, therefore you need to request for the penalty to be removed.

Remember, we are all enjoying a borrowed equity, due to prices of homes sky-rocketing. But there are signs of a slowdown. You should know that nothing will ever only go one way--it's always a two way street. As for the real estate market, it's always a cycle and it's just a matter of when the next cycle will come.

by Ken Go
References and Bibliography

Ken has been running his southern California home loans business since 1987. His honesty and courtesy equal loyalty to his customers. Forget about "good faith estimates." With 1st Innovative Finance Group, all loan rates and fees are guaranteed upon application. Ken Go writes a California home loans blog and speaks English, Chinese, and Filipino (Tagalog).

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