By Scott Craig

(A friend of Bob Meyer in Southern California wrote this piece and submitted it to the Los Angeles Times as well as one of California’s Senators, Barbara Boxer.)

The sub-prime problem is being worsened by an aggressive lending practice that is getting little publicity – and that is the huge problem of “Hard” Prepayment Penalties. Borrowers who are getting into trouble as their loans are adjusting so high that they can’t make the payments or they are building a huge principal balance if they are making the minimum payment (negative amortization) and are forced into selling, but many times they cannot.

Most borrowers don’t know that there are two types of pre-pay penalties, a “Soft” and a “Hard” pre-pay. A “Soft” penalty is only charged if the borrower refinances. (No charge if they sell.)

But a “Hard” penalty is charged no matter how the loan is paid off, i.e., when the borrower refinances or sells.

This is the big problem that I am seeing very often these days. The pre-pay penalties are typically so huge that sellers may not be able to sell. I’ve seen it many times recently, with pre-pay penalties of $12,000, $16,000 and $18,000.

I worked with one client recently, who was not even sub prime; both had good professional jobs and their credit scores were in the low 800’s – these are “A”+ borrowers. But they had a “Hard” pre-pay penalty that cost them $16,000 in order to sell and pay off their $595,000 loan. And the penalty was effective for 36 months.

Fortunately for these people they had put enough money down on the property so they were able to lose the $16,000 and survive.

But, most of the people in the sub-prime category do not have $16,000 or $12,000 into the property, or in the bank, and they literally cannot sell. Their alternative is to possibly walk away from the property.

I believe that the “Hard” pre-pay penalty is predatory in any situation, sub-prime or “A” paper, and I truly believe that it should be illegal. And worse, I believe most sub-prime loans carry the harshest form, a 36 month “Hard” pre-pay penalty.

It’s one thing to have a “Soft” pre-pay penalty if a borrower decides to refinance but it is obscene when a borrower is forced to sell and have such a harsh penalty.

And even a “Soft” pre-pay penalty should have a maximum time of 12 or 18 months. In the example above, it is totally predatory, in my opinion, to have a 36 month “Hard” pre-pay penalty.

If the government is to intervene in any way with the sub-prime problem they should make all “Hard” pre-pay penalties null and void and that practice should be a thing of the past.

This would allow a good portion of the borrowers who are in trouble to actually sell before it is too late. And this will also generate movement in the currently sluggish real estate market.

Scott Craig is the founder and president of
Pacific Equity Real Estate (DRE #01453093)

For more information on Scott Craig and Pacific Equity
see: Pacific.

Scott Craig’s book, “I’m In Sales! Don’t Tell My Mother.”
see: Craig.

This entry was posted on Monday, April 9th, 2007 at 7:45 am and is filed under Real Estate, Top Resources. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.