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Avoiding the Prepay Penalty When Refinancing

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Even when the economy is healthy, and the real estate market is stable, refinancing is always being discussed and examined as a way to save and increase the return on an investment property. Everyone wants to lock in long-term reasonable rates, especially when interest rates are as low as they are now, but some run into a pre-payment penalty when they apply for a refinancing of their current loan.

Qualifying for loans and “refis” is very difficult now with the banks and lenders who helped foster the current crisis now pulling back and offering very little. Borrowers are discovering they do not have sufficient income to refinance the property where they have lived or worked for the past several years, are being told they do not qualify for the lower rates and this frustration, compounded with being told that they will face pre-payment penalties on their currently held mortgage despite having sterling credit and as good a payment history, is making them angry.

It is easy to say that the surest way to avoid a pre-payment penalty is to not agree to one when signing the original mortgage contract, but that is hindsight which does not help too many folks. Here are a few pointers that may help those looking to avoid the pre-payment penalties and get refinanced at the lower rates:

  1. Understanding what a prepayment penalty is should be the first thing on the list. The fee a borrower pays a lender when repaying a loan before its scheduled time of maturity. Lenders like to impose these terms for a specified amount of time on a mortgage to guarantee that they get a certain return on their investment. The penalty is typically a percentage of the mortgage balance.

  2. The easiest and most obvious solution to all pre-payment penalties is to not ever enter into an agreement that has them.

  3. If you discover after the fact that you have entered into a loan agreement that has a pre-payment penalty clause there are a few things that you can sometimes do to help you avoid paying the penalties? If you are planning to continue living in your home after pre-paying the current mortgage ask your lender if they will waive the penalty fees if you re-finance with them. This is most always the easiest way to get the lender to cooperate.

  4. Some pre-payment clauses have an expiry date of only two or three years. If this is the case with your loan then waiting to re-finance may be your best or only option. Rather than make the payments deposit the money into an interesting bearing account and when the penalty period is over start paying down the loan as fast as you want to.

  5. As we’ve said, knowing beforehand if penalties will apply if a mortgage is paid-up early is very important and will help investors avoid problems at a later date. By reviewing the mortgage and consulting with their real estate attorney investors will be fully prepared to understand and negotiate the terms of a mortgage. If there are points that are not understood then they should start asking questions. If the questions are avoided, or the answers seem cursory, it may be time to find someone else to deal with. The only real way to keep away from paying a prepayment penalty is to never get locked into one to begin with.

  6. Understanding mortgages and refinancing is paramount to getting a good loan agreement and not paying penalties for early payment. Many lenders rely on the fact that most investors are beginners or novices, have not read the mortgage document completely, and do not understand a lot of it. Read it and understand it, all of it.

  7. Look at your Truth in Lending disclosure. If there is a clause similar to "you will not be entitled to any rebate of part of the finance charge if you prepay," ask the lender to be very specific and tell you what this refers to. (If you are dealing with an individual private lender you may not have one of these.)

  8. In many states pre-payment penalties are not even allowed, they are illegal. In these states they have very strict rules and guidelines that limit how much and when penalties can be applied, if at all. A real estate attorney within the jurisdiction where your loan is can best advise investors about these laws.

  9. Try to deal only with lenders you trust. If you do not have previous experiences with someone then ask friends and relatives who they have dealt with. You can also check up on these people with your local better business bureau. If dealing with a lender over the Internet borrowers need to be very cautious that they are not unscrupulous business people hiding behind the anonymity of a website.

  10. When you are getting close to closing on a mortgage request copies of all the documents you will be asked to sign on closing day. Review them with your real estate attorney and make certain that everything that was previously discussed is covered in those documents accurately. If there is a discrepancy it can be dealt with before you agree and sign.

Having an understanding of the process in general, and your mortgage and re-fi situation specifically, is always your best weapon in today’s investment and real estate market. Talk to other people you know and ask them what their experiences were and how they resolved similar problems. Many community colleges, local clubs and associations offer classes and adult-extension courses on investing, real estate, homeownership and home finance, use the Internet to find them. Keep abreast of any changes locally that could be in your favor as the mortgage and finance laws are being rewritten to help resolve the current collapse of the markets and lending.

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