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Question on Prepayment Penalty


mcck
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I signed a refi with prepayment penalties. Did anyone in the group ever refied sooner than the prepayment length of time and how were you able to avoid paying the prepayment penalty?

I am thinking to refi my mortgge from subprime to a normal rate. I am even thinking of asking the current mortgage holder to see if they would reduce the rate to stay with their company. They still make $$, but just a bit less instead of losing a customer all together.

Any thoughts?

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Whether or not you refinance and pay the prepayment penalty depends alot on the amount of the prepayment penalty, and how much you may be able to save by refinancing, and paying to refinance.

What is the loan amount, current interest rate on your loan, the type of prepayment penalty and how much would the prepayment penalty actually be. Ideally you would want to lower your payments enough so that it would make sense, but if the current mortgage payment is causing other financial hardship, then you may still consider biting the bullet now, so you still have a house when the prepayment penalty ends.

It would not be a bad idea to ask the lender to see if they would waive the prepayment penalty to refinance the loan, because if you are in good standing, they would like to keep you as a customer. Just be sure that they will offer you a good competitive rate, and not just pacify you with a little reduction in interest rate and then stick you with another prepayment penalty.

One last note, when you are using your cost of refinancing, remember that prepayment penalty amounts are tax deductible as mortgage interest if you file 1040 long form.

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Thank you for the response.

The mortgage is $288000 started in December 2006, with 3 year adj 9% and the prepayment is 5% of the total loan. The house is worth 320000 or more or less based on housing prices. Monthly bill is $2317. Would like to go down to a 7% or less and 30 year fixed. My credit seems is getting better because of what I have learned here. We have been receiving more offers from mortgage brokers to get us back down to non subprime rates.

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While there is no set amount, an early repayment penalty is usually equivalent to one or two month’s interest. The earlier in the term you repay the loan, the higher the charge as the interest component of the loan repayment makes up a higher proportion of the repayment, the earlier in the loan term it is. An early repayment penalty can add a considerable cost to your loan.

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Taken from IRS web site.

Mortgage prepayment penalty. If you pay off your home mortgage early, you may have to pay a penalty. You can deduct that penalty as home mortgage interest provided the penalty is not for a specific service performed or cost incurred in connection with your mortgage loan.

Above mortgageman has good advise about asking your current lender to wave your prepay penalty. Though 9 times out of ten you are going with another lender.

A prepay is setup when you start the loan. Depending on the borrowers credit, LTV, closing costs, etc.. This is used to calulate a lower interest rate. If a borrower does'nt want a prepay, the interest rate is higher.

My $00.02

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Since a prepayment is standard on many mortgages in the state of Indiana, then this would not be classified as a specific service performed. The only way that it would be classified as a cost incurred would be if (and I doubt this happened) the borrower WANTED the prepayment penalty to lower the interest rate on the loan. This is my humble opinion, and yes, professional tax advice would be helpful.

So, the best advice I can give in this situation would be to stay the course until your credit is in very good shape, and look at a refinance at that time. This way you will qualify for interest rates in the low 6% or even high 5% range. This is where you want to be.

Next, you will need to calculate your costs of refinancing. This will be the total cost of acquiring the new loan, plus the prepayment penalty amount. Once you have this total, then you will divide the cost of refinance by the difference in monthly payments. You will need to stay in the home long enough to recuperate these expenses, or it not really worth the price of refinancing.

Example: $14,400 (prepayment penalty)

+ 7,500 (cost of refinance)

= $21,900 TOTAL

Let's say you will save approximately $500.00 per month on your new loan (with closing costs financed).

It will take approximately 44 months to recuperate the costs of refinancing.

Please tell me the prepayment is for only three years (to match your ARM term), because in this market, I have seen some awful 5 year prepayments on two year ARMS and three year ARMS, and the whole situation would change.

P.S. Since there may be uncertainty on the IRS deduction, you may want to just consider that portion as a gift and not calculate into your costs of refinancing.

Gary, thanks for the heads up on the IRS. It appears it its not a one shoe fits all scenario, and I would hate to mislead anyone.

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