Loan deals for pledging not to prepay

Nation's Housing

January 07, 1996|By Kenneth R. Harney

WASHINGTON -- Homebuyers and refinancers nationwide are likely to get a new carrot dangled in front of them when they apply for a fixed-rate mortgage this year: Discount rates and fees, if borrowers agree not to pay off their loan within the first several years -- and are willing to pay a cash penalty if they do.

The deal your lender offers may sound something like this. Instead of you paying our standard 30-year fixed rate of 7 1/2 percent, we'll knock a quarter of a percentage point off that quote, or we'll pay $1,500 of your closing costs, if you lock yourself in with our no-prepayment pledge. The pledge commits you to pay a preset penalty if you pay off more than 20 percent of the mortgage within 36 months of the closing date.

On a $150,000 loan balance with a 2 percent penalty, for example, that would translate into a $2,400 early-payoff charge.

How can you assess whether that might make sense for you? Start with some basics. According to Washington mortgage attorney Andrea Lee Negroni, prepayment penalties are not legal on home loans -- even as an option to the consumer -- in six states (Pennsylvania, New Mexico, Alaska, Vermont, West Virginia and Alabama). Another dozen states impose restrictions of some type on lenders' ability to offer or require prepayment fees.

[In Maryland, you can prepay up to one-third of your mortgage in the first three years without any prepayment penalty. For that portion in excess of one-third, the penalty is two months' interest on the entire loan.]

James Cotton, marketing vice president at the Federal Home Loan Mortgage Corp., says consumers should look hard at four key features of the deal they're offered:

* The depth and type of price break. Mr. Cotton says the deepest rate discount he's seen offered so far is a 0.375 percent cut, but that price breaks of 0.125 percent to 0.25 percent are more typical. As an alternative to rate cuts, some lenders plan to reduce points or other fees in connection with the mortgage origination. On a $200,000 loan, a 1 point discount is worth $2,000 to you.

* The length of the no-prepayment "lock" period. The shorter the better for the borrower.

* How flexible is the no-prepayment deal? Some lenders plan to allow early loan payoffs without penalty when a borrower sells the house because of a job change or other reason.

* How stiff is the penalty? Generally lenders allow up to a 20 percent prepayment without penalty, and hit you with a 2 percent fee on the 80 percent balance. Some programs can penalize you six months' interest.

Todd Hempstead of the Federal National Mortgage Association says borrowers should approach prepayment loan offers with a "risk-reward" computation. Are the odds strong that you'll stay with the loan for the three years necessary to avoid the penalty? And is the price break sweet enough to make you take on the risk of a penalty?

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