Please register to participate in our discussions with 2 million other members - it's free and quick! Some forums can only be seen by registered members. After you create your account, you'll be able to customize options and access all our 15,000 new posts/day with fewer ads.
Your loan is bundled up with others in a CMO tranche (Fixed Rate Tranche) and sold to investors. If you prepay on your loan, you are removing your loan from that pool and therefore investors will not receive interest payments for your loans.
For example, lets say you owe a remaining $10,000 of interest on your loan over the remaining 3 years of the fixed term of your loan. If you prepay that loan, the investors lose out on that interest. If the bank reinvests your prepayment money at the "replacement rate," maybe they can only get $9000 of interest over the same 3 years to pass on to investors. In this case, the bank may charge you that $1000 difference.
Essentially, the nature of mortgage backed securities is that investors are exposed to prepayment risk if the interest rate goes down. The fixed rate tranche that your loan will be packaged into has protections in it to transfer that risk from the investors to you, which is why your loan has this provision in it.
The original post was written a few years ago, but wow, I never knew such terms existed for a loan. No one should ever sign such an obligation, and I am surprised they have not been made illegal. Assuming that lots of loans from that period had such a stipulation, no wonder people were going bankrupt and losing their homes due to foreclosure. You would not even be able to refinance your home unless you could either pay the penalty (which would have been high in the early years of a loan) or roll it over into the new mortgage which would have negated the usefulness of a refi. Unbelievable usury.
The original post was written a few years ago, but wow, I never knew such terms existed for a loan. No one should ever sign such an obligation, and I am surprised they have not been made illegal. Assuming that lots of loans from that period had such a stipulation, no wonder people were going bankrupt and losing their homes due to foreclosure. You would not even be able to refinance your home unless you could either pay the penalty (which would have been high in the early years of a loan) or roll it over into the new mortgage which would have negated the usefulness of a refi. Unbelievable usury.
They may exist but I know of no country in the world where you could take out, for example, a 10, 20, or 30 year fixed rate mortgage and pay it back the next day with no penalties!
That has been good for US consumers in residential but it's not the way life works. It only worked that way because this benefit was subsidized by the government.
Think about it. You could get a 30 year FIXED RATE mortgage at 5% and rates go up to 15%. You still enjoy a 5% rate. Rates instead go down to 3% and you can refinance with no penalty. All upside benefits with no downside risks. The normal way for it to work with the absence of government subsidies would be for there to be early repayment fees/penalties while the loan is in its fixed rate period. So if you have a 30 year mortgage with the first 10 years with a 6% fixed rate, you can't do an early repay without fees within the first 10 years. If a consumer wants flexibility to repay/refinance, then they go for a shorter fixed period or a fully variable rate. Fixed rate periods are backed by real investments with periods that align with the fixed rate period of the loan so someone pays when the benefit of 'free' early payment is given to the consumer.
I'm not against subsidies for various things by the way, just responding to you suggesting that this practice is somehow unreasonable. It's actually very natural, the way economics works, and the way it works in almost all places in the world.
Even if you pay the mortgage loan back the next day, the loss to the mortgage company is not very large. The buyer has already paid some points and origination fees. Yes, the paper work may have involved several hours of a loan officer's time, but that is all. If the money is transferred to the mortgage holder then no harm no foul, that money is available for the next loan to be made. None of the properties I have ever bought had a prepayment penalty. The mortgage holder merely looked at my situation and probably realized that I would be good for at least a year or two.
Some of your comments just-because make me wonder if you have done most of your work in another country. For example, I have never heard of a fixed rate, 10 yr period on a 30 year loan. All 30 yr loans I have seen are 30 yrs at the same rate. Who would run the risk of a huge rate increase a third of the way through the loan span?
Even if you pay the mortgage loan back the next day, the loss to the mortgage company is not very large. The buyer has already paid some points and origination fees. Yes, the paper work may have involved several hours of a loan officer's time, but that is all. If the money is transferred to the mortgage holder then no harm no foul, that money is available for the next loan to be made. None of the properties I have ever bought had a prepayment penalty. The mortgage holder merely looked at my situation and probably realized that I would be good for at least a year or two.
Some of your comments just-because make me wonder if you have done most of your work in another country. For example, I have never heard of a fixed rate, 10 yr period on a 30 year loan. All 30 yr loans I have seen are 30 yrs at the same rate. Who would run the risk of a huge rate increase a third of the way through the loan span?
As explained, it's not about the admin costs, it's about the long term instruments that back/enable a 30 (or whatever) rate guarantee. If you do a little research on the basic concepts of this, I think you'll find that I'm correct in the concept that I explained. While it might be a boring topic with a lot of detail, it's worth understanding the basic principles of it.
Stoxdiamond explains it a slightly different way but same concept. See his/her post below describing pre-payment risk. In the US residential market the government subsidized this risk, enabling the very valuable gift of 30 year fixed rate guarantees which the consumer can exit at their whim but the lender must honor for 30 years.
The original post was written a few years ago, but wow, I never knew such terms existed for a loan. No one should ever sign such an obligation, and I am surprised they have not been made illegal. Assuming that lots of loans from that period had such a stipulation, no wonder people were going bankrupt and losing their homes due to foreclosure. You would not even be able to refinance your home unless you could either pay the penalty (which would have been high in the early years of a loan) or roll it over into the new mortgage which would have negated the usefulness of a refi. Unbelievable usury.
it was a commercial loan, not a personal mortgage.
if you go back and re-read the SnugBuffalo post that resurrected the years-old post, it will be as clear as possible.
In the old days, we also sometimes had prepayment penalties on mortgages for the early years. When the lender was giving the buyer/borrower a "great deal" or otherwise issuing a mortgage that had to be held in-house (couldn't be sold on the secondary market), it was used more frequently.
Typically a prepayment penalty was a % of the balance (or balance paid) and declined from years 1-3 to 5 when it extinguished. For example, you might see a 4% prepayment penalty in year 1, 3% year 2, 2% year 3, 1% year 4, and then 0%. And it even applied sometimes when someone sold their home before that end date.
also, lenders issue ARM's each and every day. It's just that in a rising rate environment, it makes little sense not to lock yourself for the full 30 year term allowed.
And most ARM's have rate change caps, both the first time (7th year for ex), annually, and a max (most I've seen is 3% above original rate).
Please register to post and access all features of our very popular forum. It is free and quick. Over $68,000 in prizes has already been given out to active posters on our forum. Additional giveaways are planned.
Detailed information about all U.S. cities, counties, and zip codes on our site: City-data.com.
Please register to participate in our discussions with 2 million other members - it's free and quick! Some forums can only be seen by registered members. After you create your account, you'll be able to customize options and access all our 15,000 new posts/day with fewer ads.
