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1.3.3.3 Role of Prepayment Penalties in Refinancing Out of Bad Loans

Particularly in subprime loans, prepayment penalties often trap the homeowner in a loan even after the homeowner discovers that the loan terms are not what she was led to expect. One study found that about eighty percent of subprime loans contained prepayment penalties, compared with only two percent of loans in the prime market.279 These prepayment penalties created a significant barrier to refinancing a bad loan into a better one. As a result, prepayment penalties—which were more restricted prior to deregulation—shielded lenders from fair competition. The Dodd-Frank Act has restored some, but not all, restrictions on prepayment penalties.

Footnotes

  • 279 {279} John Farris & Christopher A. Richardson, The Geography of Subprime Mortgage Prepayment Penalty Patterns, 15 Hous. Pol’y Debate 688 (2004). See also U.S. Dep’t of the Treasury & U.S. Dep’t of Hous. & Urban Dev., Joint Report on Recommendations to Curb Predatory Mortgage Lending 93 (2000) (showing a 70% rate for subprime loans and a 2% rate for prime loans); Ellen Schloemer, Wei Li, Keith Ernst & Kathleen Keest, Ctr. for Responsible Lending, Losing Ground: Foreclosures in the Subprime Market and Their Cost to Homeowners, available at https://www.responsiblelending.org (showing incidence of prepayment penalties in subprime loans ranging from 54.37% to 71.70% from 1998 to 2005).