Florida Mortgage Refinancing Problem: The Prepayment Penalty

With rates on many homeowners’ adjustable-rate home loans rising, some who would like to Florida mortgage refinance into a new loan are finding they can’t.

In some cases, that is because their loan carries a prepayment penalty, which would force them to come up with thousands of dollars if they refinance in the first few years. Such penalties are common with so-called option adjustable-rate mortgages, which typically carry a low teaser rate that rises sharply after an introductory period.

Other borrowers are getting caught short by a changing housing market - one in which home prices have flattened and lenders are beginning to tighten their standards after a long period of making Florida mortgages easier and easier to get.

The challenges are greatest for homeowners whose credit has declined since they took out their last loan and for those who have little if any equity. Some of these borrowers are still able to refinance but are finding it more costly than they expected.

These new challenges come at a time when many borrowers who took out adjustable-rate mortgages are facing higher payments. There are about $1.1 trillion to $1.5 trillion in ARMs that will face rate increases this year, according to the Mortgage Bankers Association. The MBA expects borrowers to refinance as much as $700 billion of those mortgages.

“The decrease in property values, combined with prepayment penalties, is making it very challenging for people to get out of these loans,” says Ed Shanks, an executive vice president with U.S. Bank Home Mortgage, a unit of U.S. Bancorp.

In recent years, many homeowners refinanced repeatedly - to get a better rate, lower their payment, consolidate debt or pull out cash. Even now, Florida home loan rates remain relatively attractive, though they have moved up from their recent lows in early December, and most borrowers still should be able to take advantage of them. The challenges for homeowners could increase if lenders continue to tighten standards and the housing market remains soft.

Antonio Papa, a construction worker, took out an option ARM with a 1% introductory rate in 2005 on a second home he owns in Jupiter, Fla. The rate jumped to 5.6% in September 2005 and has since climbed to 7.5%.

“I was looking to refinance to have more stability,” he says.

He has decided to hold off because his option ARM carries a prepayment penalty that would force him to pay six months’ of interest if he refinances within the first three years. Mortgage brokers often receive higher payouts for putting borrowers into a loan with a prepayment penalty, says Sandra Barrett, a loan officer in Palm Beach Gardens, Fla., who was working with Mr. Papa.

Prepayment penalties are most common with option ARMs and Florida home loans made to borrowers with scuffed credit. Some 84% of option ARM loans made last year carried a prepayment penalty, according to an analysis by UBS AG that looked at mortgages that were packaged into securities and sold to investors.

The challenges facing borrowers are becoming more apparent at a time when opportunities for refinancing are narrowing. Rates on 30-year fixed-rate mortgages dropped to their lowest levels in 14 months in December, but have recently drifted higher. Rates on 30-year fixed-rate loans currently average 6.45%, according to HSH Associates in Pompton Plains, N.J., up from 6.16% in early December.

“The best deals in going from an ARM to a fixed-rate are passing,” says Doug Duncan, chief economist at the Mortgage Bankers Association. “If anything, rates are likely to move up rather than down.”