Thursday, October 26, 2006

Prepayment Penalties

As the mortgage industry loosens its standards to attract sub-prime, self-employed, low income, and other "out of the box" borrowers, they are also imposing safety nets to protect their loan. These safety nets help the lender counteract the risk of taking a non-conforming loan. Some of these tactics include high-interest rates, big down-payments, proof of cash reserves, and pre-payment penalties.

Prepayment penalties are penalties imposed on borrowers who sell or refinance their home too quickly after purchase. Many prepayment penalties are 1-2 years in length. If you sell or refinance your home prior to your time limit, the lender will impose a cash penalty at the time of closing. These penalties are often 6 months interest on your loan, or 5-6% of the total value of your loan.

Lenders are smart. They know that many people who need sub-prime and other nitch loans often need to sell their home quickly due to a relocation or financial burdens. The lenders will gladly collect $5000, $10,000, or $20,000 of your equity simply to allow you to move.

My advice is this: Be careful of loans with prepayment penalties. If you do take a loan with a prepay make absolutely sure that you will be living at your home long enough for the prepay to expire. If not, you may end up selling your home and bringing money to the closing table.

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