Home owners who've developed a habit of refinancing every time rates drop a half point or more in recent years, may now find themselves unable to benefit from refinancing to yet lower interest rates without paying a prohibitively expensive prepayment penalty.

"Occasionally an investor will waive the prepayment penalty when it is a portfolio loan, usually an adjustable, complete with, you guessed it -- another prepayment penalty," said Ginny Ferguson, a committee chairman with the National Association of Mortgage Brokers.

But that's rare.

Prepayment penalties can be as high as six months worth of interest payments on 80 percent of the balance on your mortgage. They typically are tacked onto mortgages by lenders to reduce their risk when making loans to borrowers with credit dings and other risk factors.

Attached to loans that are already higher cost loans because of the borrowers credit or other qualifications have put them in a "subprime" category, the penalties are also designed to discourage borrowers from just what they may be after right now -- refinancing to take advantage of record low interest rates.

"They have put that penalty in place to keep a loan on the books for a specific period of time, because 1), the investor that funded that loan has a generally paid all of the borrowers closing costs on the refinance that originated the loan and it takes a significant number of payments before the investor has recovered that investment or 2), the consumer got a lower interest as a trade off for the prepayment penalty," said Ferguson, also vice president of Heritage Valley Mortgage in Pleasanton, CA.

"Too many consumers think that it is okay to refinance over and over again for as little as an 1/8 percent (rate reduction) after some investor just absorbed $3000 to $4000 in fees on his or her behalf and before they even make the first payment to the investor on the new loan," she added.

Some states outlaw them or severely restrict them, but the penalties evaporate after three or more years. Last year Freddie Mac stopped buying subprime mortgages with penalties that exceed three years.

Some penalties are trigged when the loan is retired for any reason -- refinancing, a home sale, making additional principal payments. On other loans, the penalty is due only when the mortgage is refinanced or principal payments exceed a certain level.

In any event, your broker, if you use one, should help steer you away from prepayment penalties and explain the details of any penalty you may choose to accept -- say to get a lower rate or so-called "zero-cost" loan that might tack on a prepayment penalty.

The prepayment penalty is just one reason borrowers must take the time to read the small print or get someone qualified to scrutinize the loan papers.

"Sometimes you'll find penalties on seconds and they may be something like 1 percent of the balance, which may only amount to a few hundred dollars or a flat fee," said Darrell Evans a loan consultant with Direct Access Lending in Las Vegas, NV.

In any event, once the prepayment penalty is included, it's harder to shake than Crazy Glue. Chances are, you are stuck.

"Not asking is an automatic 'NO!' And while you can, of course, ask for whatever you want, when you want it. Once those papers are signed, you lose your bargaining strength -- unless you're in a state that doesn't allow prepayment penalties," said Nancy Castleman, of the Good Advice Press in Elizaville, NY. which offers financial advice.

"To make sure that there'll be no prepayment penalties on your mortgage, deal with it at the get-go. That's the best time to get them waived. If a lender charges them and won't waive them, there are 50 or so other lenders who'd be very happy for your business," Castleman said.

Some experts say there are rare occasions, say if you refinance with the same lender, when a prepayment penalty may be waived, but any waiver is at the lender's discretion.

"Lenders can voluntarily waive prepayment penalties. They used to do this if you took a new loan with the same lender. This does not seem to be the case any more," said real estate attorney David Hofmann, with the San Jose, CA law firm of Steinbock and Hofmann.

"Most lenders now understand when they can include prepayment penalties and will include them whenever they can. Most good loan brokers try to avoid having their clients agree to prepayment penalties, even if it means paying a little higher rate," Hofmann added.

Marie Sternberger, an enrolled agent in Sunnyvale, CA says if you are stuck with a prepayment penalty, the best you can hope for is a tax deduction. A prepayment penalty is considered interest you can deduct on you tax return.

An interest deduction, however, only reduces the amount of income against which you are taxed -- unlike a tax credit that directly reduces your taxes, says Sternberger.

Published: March 20, 2003

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Broderick Perkins parlayed a career in old-school journalism into a contemporary digital news service that really hits home. The award-winning consumer journalist, originally from Wilmington, DE, is founder, publisher and executive editor of the bootstrap DeadlineNews Group, a Silicon Valley-based editorial content and consulting service specializing in residential real estate, consumer news and related editorial consulting services. The DeadlineNews Group includes the website, DeadlineNews.com, offering real estate editorial content and consulting services, and its back shop, the Deadline Newsroom, an open house on news that really hits home. Perkins obtained his formal journalism education from University of Delaware and a journalism boot camp, the Institute of Journalism Education at the University of California-Berkeley. He went on to 20 years of service as a daily newspaper journalist at the Wilmington, DE News Journal and San Jose, CA Mercury News. Perkins covered housing on the San Jose Mercury News reporting team which earned a General News Reporting Pulitzer Prize in 1989 for coverage of the Loma Prieta earthquake. He has also produced real estate, consumer and small business content for the Wall Street Journal, Los Angeles Times, RealtyTimes.com, Nolo.com, Better Homes and Gardens, the National Association of Realtors, Homestore/Move and Intuit/Quicken among more than three dozen publications. In addition to managing the DeadlineNews Group, Perkins most recently served as chief editorial consultant for Nolo's Essential Guide To Buying Your First Home, Nolo, and writes real estate television scripts for RealtyTimes.com.