Undoubtedly you have heard numerous commercials touting the fact that money is available for you to pay off those high interest credit cards. Many lenders and the investment community have structured loans that will allow homeowners to borrow 25% or more than the value of their homes. How this phenomenon has come about over the past two years, I will address in the future. For now, it is important to know that some of these loans as well as other real estate loans have within them a term that should be disclosed and explained to you, the borrower. "Prepayment penalties" on real estate loans once were very common. As the term states, there is a penalty to you the borrower, that becomes a fee paid to the lender, for paying off your loan before maturity or earlier than allowable in the contract.
The terms of real estate loans are not uniform. As a borrower you should shop for the best rate and terms to fulfill your purposes. However, as you negotiate the rate, you should also negotiate the terms of the loan. Many second trust deeds, helping you consolidate those credit card balances, will have prepayment penalties as part of the terms. This, as I said above, should be disclosed to you. Knowing that a prepayment penalty exists within a particular loan gives you needed information for making a judgment call that the loan is right for you.
If you plan to repay the loan within a year or two, be certain that this amount of time is the extent of the prepayment penalty. It can be a shock to your financial well being upon selling your home or preparing for refinancing that a prepayment penalty will be exacted and the net proceeds on your sale will be reduced by a substantial amount or the costs of refinancing will be higher than anticipated. You may also find that this extra amount of money due at closing may preclude you from making the move you anticipated. I have discovered most people do not remember the terms of the loan that currently encumbers the home. It truly is a surprise to them that a substantial amount of money can be extracted from them for an early payoff of the loan.
The right to prepay a loan is granted by statute. Although granted by law, it does not mean that the borrower has an absolute right to prepay the obligation. Whatever borrowers' rights to prepay exist are determined by the terms of the obligation. You do not want to get into a discussion of penalties and prepayment procedures when you are ready to make a move or refinance your property. The best way to protect yourself is by reading your contract (note) and understanding your rights and obligations under that contract. This particular area should not be left to speculation, since it can cost you many dollars and possibly impact your lifestyle. Any obligation regarding real estate must be in writing. Accept only what is on paper and not verbal commitments.
Earlier this year I worked with a client whose property was encumbered by a conventional first trust deed and a second trust deed carried back by the seller. The seller incorporated a prepayment penalty into the second trust deed. When we received the payoff figures from the seller, we noticed that the seller was asking for a prepayment penalty equal to six months interest on the entire original loan balance. Our client had already made payments for two years and by statute had the right to make a 20% prepayment of original principal balance every year. Catching the error by the holder of the second trust deed (the seller), we saved the client over $600.00 in prepayment fees to the borrower. State laws vary regarding prepayment penalties. By California law, loans on owner occupied properties can be prepaid by up to 20% of the original principal balance each year without penalties. Do not hesitate to verify any prepayment fees calculated by your lender; mistakes can and do happen.
As you research your loan options and request quotes for that second trust deed to consolidate you debts, do not only ask about the rate and term of payments, but also whether there is a prepayment penalty. If two rate quotes are comparable, one without a prepayment penalty and the other with a prepayment penalty with all other costs the same, the loan without the prepayment penalty will save you considerable money if you plan to payoff the loan before the agreed upon term. Many lenders will allow you to "buy out" the prepayment penalty by either increasing the points on a loan or by increasing the interest rate. If a prepayment penalty exists, you can ask your lender to quote a "buy out" cost. You then can decide whether the extra "up-front" cost or the increased monthly payment will afford you the peace of mind necessary to plan your financial future.
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