mortgage

6 steps to a lower prepayment penalty

As the economy has dragged, many people are seeking to reduce their monthly financial obligations by paying off pesky second mortgages or refinancing their home loans to a lower interest rate. Some, however, are discovering an unpleasant extra cost as they make these changes: prepayment penalties.

Over the past few years, as housing prices skyrocketed and borrowers needed to find the cheapest possible way to finance their needs, banks used prepayment penalties as a way to lure buyers with low rates while locking in their profits. The idea was that the banks would lower their rates by a smidge -- perhaps a quarter percent -- but demand that buyers sign a contract to pay a penalty if they paid off their mortgage in a set period of time, usually between three and five years.

These contracts were structured to guarantee a certain amount of profit, says Ilyce Glink, publisher of ThinkGlink.com and the writer of a syndicated column called "Real Estate Matters."

"The banks would do a risk calculation or a profit calculation, and the penalty itself was generally set between 2 percent and 4 percent of the loan," Glink says.

For example, a penalty of 2 percent on a $200,000 mortgage would amount to $4,000.

While borrowers are required to sign disclosures about the penalties, they don't often notice them in the stack of papers they're required to sign at closing. And now, as they seek to pay off or refinance the loan, the penalties are coming back to haunt them. The fees may seem shady, but they're not illegal.

"With a mortgage, you've entered into a legal contract, and most of the time, (the bank is) not going to want to go to the effort to renegotiate it," says Clarky Davis, Debt Diva at CareOne Debt Relief Services in Raleigh, N.C.

Even so, there are some ways to help reduce the financial pain of these costly penalties. Here are six steps to follow:

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1. Check your contract. Be sure you have a prepayment penalty by sifting through your stack of mortgage papers. "It usually says 'prepayment disclosure' or 'prepayment penalty disclosure,'" says Glink. "There are usually three or four documents you've had to initial to indicate that you've read them."

2. Read the fine print. Some prepayment penalties are a single, fixed fee. Others are based on a sliding scale that decreases the longer you've held the loan. Try to get out at one year and you may pay 4 percent of the loan's cost. After four years, you may pay just 1 percent. This can be the first place to try to lower your rate. If you're close to hitting a reduced penalty threshold, consider waiting a month or two for a loan refinance or payoff.

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