interesting commentary on prepayment penalties

[walkitout]

I've done some whining here about the things people sign up for in other-than-boring-old-fixed-rate-FHA-style loans (recourse vs. non-recourse, prepayment penalties, rapid changes in mortgage servicers due to repeated sales of the mortgage, loss of the ability to negotiate a workout because the mortgage has been bundled and sold to investors, etc. -- and that's not counting evils like negative amortization in Pick-a-Pay).

Here, Tanta, the other contributor to the Calculated Risk blog, presents an interesting take on prepayment penalties:

http://calculatedrisk.blogspot.com/2008/07/prepayment-penalties.html

The gist is simple. Even ignoring issues of discrimination and lying (where people don't know what they are signing or don't know there are alternative choices), customers tend to assume the prepayment penalty won't be an issue for them (they don't plan to sell in this case) or that rare, negative events that change their plans won't happen to them (getting cancer, in this case).

Tanta's analysis is interesting, because she _doesn't_ agree with the rationale provided/implied by the victim, but absolutely opposes prepayment penalties because it's quite clear it is a component of the product that is misunderstood and misassessed by the customer.

I would extend this to all kinds of other situations deserving of regulation, but I recognize that everyone is going to draw the line somewhere. This, tho, seems like a pretty good one to ban.

Comments

[ethelmay.livejournal.com]

Wow. I didn't even KNOW that you paid the prepayment penalty if you actually *sold the house*. I thought it just meant that while you owned the house, you couldn't make extra payments toward principal and like that. That is just sinful.

good explanation of the varieties of prepayment penalties

[walkitout]

When I discussed this with R. just now, I realized that we had different understandings of prepayment penalties so I did some looking around for details. Here's a very detailed explanation of the varieties out there:

http://blownmortgage.com/2007/10/12/choosing-a-pre-payment-penalty/

In particular, some prepayment penalties are triggered by selling the property and some are not. According to the above, some prepayment penalties are not enforceable in some states.

Here's a remarkable comment from the above:

"Most people’s financial position is not as stable as it looks, and changes in employment, desires to change residences, or other economic drivers can lead to a sudden need to pay off a loan. This is true even if those same people originally foresaw no possibility of a change of this magnitude occurring during the pre-pay time period.

Because of this I recommend taking a slightly higher interest rate and monthly payment in exchange for the freedom and flexibility of not having a penalty. I look at the higher payment each month as a small insurance premium against the need to make a sudden, unexpected (and drastic) move in my home financing situation."

No need to invoke doom and gloom and imagine cancer -- just ordinary caution, like that which motivates people with dependents to buy life insurance, for everyone to buy home or renter's insurance, car insurance, etc. Unfortunately, the author follows it up by suggesting that newly-retired couple might take a prepayment penalty on a 30 year last loan they'll ever have. Words kinda fail me (to be fair, the prepayment penalty would only be for 2 years in the example).

This post refers to the above one, and adds some more information:

http://www.fhaloanpros.com/2007/10/when-is-a-prepayment-penalty-worthwhile/

FHA loans don't allow prepayment penalties, some states ban them BUT you may still wind up with one in one of those states if the lender is not regulated at the state level but rather at the federal level. This is a little different from what Blown Mortgage said.

It's a dangerous world out there.