If your mortgage has a pre-payment penalty and you default, you are still responsible to pay the early payoff fees!

There is a clause in every mortgage called an acceleration clause. This gives the lender the right to foreclosure on the mortgage. When a borrower is late on the payments, the lender is allowed to accelerate the due date of the debt to the present and gives the debtor notice of default demanding the full loan balance be paid at once. Thus foreclose and take away the house.

A pre payment penalty is when a borrower must pay a fee for early repayment of part or the entire mortgage amount due. Perhaps, the borrower agrees to pay the lender an additional 3% of the outstanding principle if they pay it off within the first three years. Most people assume this will never happen or are simply given no choice but to agree. Many loans in the sub-prime category offered loans only with prepayment penalties. It made these high risk/high interest rate loans even more profitable to the investors. The borrowers were typically backed into this type of loan and assumed they would deal with it when the time came.

And so the time has come for so many sub-prime loans gone south. As we know foreclosures have hit record levels and are expected to continue through this year. Yes, we know that many people took the wrong loan; and a loan with a pre-payment penalty is certainly an error. However, to have your house taken away because you cannot make the payments, only to find out the bank is charging you extra for “paying” it off early is usurious if not a slap in the face!  If a home is being sold through a short sale or given back via deed in lieu, the same clause holds. As part of the negotiation, try and get the lender to waive this fee.

As of this date, lenders are legally allowed to collect the pre-payment penalty; however there is talk of having it waived for loan in foreclosure. The good news is that most of early terms are for less than five years, so hopefully many of the loans have already passed the dates.