Question:

What are subprime prepayment penalties, why are they applied and how can they be avoided?

Answer:

Subprime prepayment penalties are fees that are charged to the borrower by the lender of a subprime loan if the borrower pays back his/her loan completely before it is due.

Subprime loans are high risk, high reward ventures for lenders. These loans have much higher interest rates because of poorer credit rating, or bad credit history of the borrowers which makes the risk of financing a subprime loan much higher than the risk of financing of a prime loan.

Why Are There Subprime Prepayment Penalties?

As the interest rates (hence rates of return) are high on subprime loans, lenders do not want borrowers to get out of the deal. That is why they attach subprime prepayment penalties so that if a borrower has better financing options some time down the road, he/she cannot get out of the mortgage deal without compensating the lender.  

What to do?

Subprime prepayment penalties are a norm in the mortgage lending industry and it is almost impossible for a borrower with a low credit score (i.e. a subprime borrower) to get a loan without accepting some sort of a prepayment penalty.

If you are a subprime borrower you do not have any choice but to accept the situation and try to work with it. You could negotiate a time limit on the prepayment penalties where the penalty clause becomes null and void after ‘x' number of years. You could also affect prepayment up to a certain amount be allowed every year. Negotiating these backdoors out of a prepayment can help you to later refinance your loan if better financing options become available.

A Word of Caution

Lenders sometimes slip the subprime prepayment penalty clause in the mortgage agreement without touching on it extensively. The only way you can make sure that nobody takes advantage of you is to go over all the details with the loan officer. Make sure that the contract you sign has only the terms that you have agreed upon. Otherwise getting out of the loan may become far too expensive.

Mortgage rates hit their lowest since 1955. Ask the home loan experts we recommend Quicken Loans how to take advantage of them.
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