Trying to escape a prepayment penalty

Dear Dr. Don,
Two and a half years ago, we signed a five-year prepayment penalty clause in our 30-year mortgage.  We have excellent credit -- always have.  Our interest rate is 7.625 percent on $308,000.  Obviously, given today's interest rates, if we could refinance, we'd save big. 

In your opinion, is there any creative way to get out of our PPM clause? -- Jody Juxtapose

Dear Jody,
By signing a five-year prepayment penalty clause, you should have gotten a lower mortgage rate than if you hadn't accepted a prepayment penalty. 

You took on the risk that rates could go lower and by accepting that risk you got a lower mortgage rate. 

The table below shows how saving half a percentage point on your mortgage translates into a cash savings of about $3,900 through the first 2½ years of your mortgage. 

The prepayment penalty will vary by contract, but is often six months worth of interest on the outstanding loan balance.  For your loan, that would be approximately $11,500.  Review your loan documents to correctly calculate the prepayment penalty that would apply to your loan.

I looked at the potential savings associated with refinancing your loan using current rates for a 30-year fixed-rate mortgage.   You can construct a similar table by using Bankrate's Mortgage Calculator. The results are in the table below:

If you plan to be in your home for a long time to come, then paying the prepayment penalty and refinancing can still make sense.  In my example, spending $11,500 plus closing costs today to save $115,000 to $220,000 in interest expense over the life of the loan can make perfect sense. 

I'd like to point out three things about the table.  First, I assumed that the refinancing would have the same term (27½ years) as the outstanding mortgage.  Second, I showed a refinancing alternative where the reduction in monthly payments was used to make additional principal payments.  This reduced the life of the mortgage to a little over 19 years.  Lastly, no tax effects have been calculated for this mortgage.  If you use the mortgage interest deduction on your taxes, then the benefit to refinancing is reduced by the lost tax savings.

Looking for escape clauses in the mortgage contract is something you should discuss with a real estate attorney.  I'm not aware of an easy out, other than some prepayment clauses allow the prepayment penalty to be waived if the home is sold.