By now all of us are at least marginally familiar with the problems stemming form the “Sub-Prime Mortgage Meltdown” in the United States. Those of us in certain areas of the counrty have seen the fallout first-hand – record high foreclosure rates, people losing their homes and neighborhoods plagued by increasing vacant boarded-up houses.
The term “sub-prime mortgage” is defined differently by different people and institutions. Basically, however, the term represents residential mortgage loans made to people with less than stellar credit. Because the risks of non-payment are higher when lending money to people with lower credit scores, the terms of a sub-prime mortgage typically include higher rates, adjustable rates and prepayment penalties. To account for the higher risk for the lender, the credit terms of a sub-prime mortgage are usually more favorable to the lender than traditional loans.
Prepayment penalties – an amount of money, usually a percentage of the original amount of the loan – payable to the lender if the borrower pays his or her loan off in full, or refinances, at some time prior to the maturity date of the loan – usually within 3-5 years of the date of the loan – are common terms in sub-prime mortgages. Because the secondary market for residential mortgage loans has grown exponentially over the past several years, your originating lender will most likely not be your lender for long. That is because large financial institutions like Countrywide, HSBC and others, in addition to originating loans, buy loans originated by other lenders, many of whom only originate loans they know they can immediately sell to a buyer in the secondary market.
Because many originating lenders are making loans with the sole intention of immediately selling them to a mortgage buyer, the originating lenders are making loans at terms that qualify for the loan programs offered by the secondary buyer. Indeed, the buyer’s loan program terms must be met before the buyer will purchase the loan. Sub-prime mortgage loan programs most often contain prepayment penalty requirements.
Loan originators may be regulated by either state or federal law. Most states have specific laws regulating the amount a lender may charge in the form of a prepayment penalty. For example, Ohio limits the amount a lender may charge as a prepayment penalty to 1% of the original principal balance of the loan, which may only be charged if the loan is paid in full or refinanced within five years of the date of the loan. See http://codes.ohio.gov/oac/1301:8-3-24 If a buyer’s loan terms do not comply with any particular state’s law, the loan could be illegal. And while loan buyers seek the exemptions from state law enjoyed by federally-regulated loan originators, it is unclear whether they are entitled to this exemption if they themselves are not federally regulated.
Prepayment penalties pose problems for strapped homeowners trying to refinance out of a problematic loan. Often the amount of the prepayment penalty makes refinancing too expensive. Mortgage loan buyers seeking to enforce the prepayment penalties that are not exempt from state law, regardless of whether the originating lender was, should be required to comply with a state’s limits on prepayment penalties.
Before paying a prepayment penalty, make sure it complies with your state’s law. In Ohio, it should not exceed 1% of the principal balance of the loan and may only be assessed within the first five years of the loan. If your loan is held by a National Bank or federal savings and loan association (thrift), they are not regulated by Ohio law. If, however, your loan is now held by a mortgage loan buyer who is not a national bank or federal thrift, you should seek to enforce your rights under Ohio law.
For more general information on prepayment penalties see Professor Jack Guttenberg’s website at http://www.mtgprofessor.com/a%20-%20options/prepayment_penalty.htm.