Your Mortgage : Lenders Offer Reward for Not Refinancing

Home buyers and refinancers across the country may soon get an important choice from major lenders when they apply for a mortgage:

Either discounted interest rates or lower closing fees, in exchange for accepting a “prepayment penalty” clause designed to discourage refinancing during the early years of the loan.

The nation’s largest mortgage banking firm, Countrywide Funding Corp., confirmed recently that it is gearing up a discounted-rate prepayment-penalty concept for introduction early in 1994.

Other large lenders either have already launched programs--such as the Bank of America--or are actively considering doing so. One high-volume mortgage lender anticipates offering novel loans in which all origination and closing fees that are normally charged the borrower are instead deferred. If the mortgage isn’t refinanced anytime in the first five years, the deferred fees--which typically amount to several thousand dollars or more--would be forgiven, wiped off the borrower’s slate.

If, on the other hand, the borrower refinanced during that time period, the fees would be included in the payoff amount owed to the lender.

The sudden surge of interest in prepayment clauses is the direct result of this year’s unprecedented boom in refinancing.

Mortgage companies that had counted on reaping steady profits from their long-term “servicing” (administration) rights on home loans have found their income streams disrupted by the heavy refinance turnover. Investors in mortgage securities who had expected many years’ worth of interest payments at above-market rates have ended up holding the bag when refi borrowers bailed out of their 8% and 9% loans en masse.

To bring greater stability and predictability to this market, lenders are looking to a classic free-enterprise solution, the quid pro quo: Give us a minimum of three or five years, and we’ll knock a quarter of a point off your rate for the entire term of your loan. Or we’ll provide you some other financial inducement, such as lower fees.

“We think that a lot of people will recognize that this is a good deal for them,” said Kevin Bartlett, executive vice president of Countrywide, based in Pasadena, Calif. The firm is active in all 50 states and has originated over $30 billion in home mortgages during the first nine months of this year.

Bartlett said Countrywide would consider offering loans with prepayment penalties “tailored to the specific laws” of each state where prepayment clauses are permitted.

For example, in California, according to Bartlett, the new loan option might offer up to quarter of a percentage point discount off the regular note rate, in exchange for a no-refi penalty. Bartlett said California law would permit a penalty of up to six months’ interest on the amount prepaid during the first five years.

On a hypothetical $200,000 fixed-rate 30-year loan in a 7% market, for instance, Countrywide might offer a prepayment-penalty option loan at 6 3/4%. The rate differential would knock the monthly principal and interest payment down from $1,330.61 to $1,297.20--a saving of $33.41 every 30 days, or about $400 over a 12-month period. The differential would save an average borrower remaining in the property for seven to 10 years at least several thousand dollars compared with a full-priced 7% mortgage.

On the flip side, however, there would be a stiff penalty imposed on a borrower who refinanced in the first several years. The full, statutory six-months’ interest during the first year would exceed $6,500--a major disincentive. Countrywide has not decided yet on precisely what mix of incentives and disincentives to offer in its upcoming program. Participating borrowers would receive detailed disclosures of the potential benefits and costs at the application stage.

A different model aimed at achieving the same result is being worked on in Seattle. Washington Mutual Savings Bank’s vice president for real estate lending, Joe Ebner, said his institution might offer “zero point” mortgages with prepayment-penalty clauses.

Rather than collecting a standard two points (2% of the loan amount) in cash from borrowers at closing, the bank might charge borrowers no fees at all up front. If the customer didn’t refinance during the next five years, the fees would be crossed off the books. Otherwise they’d be payable in full.

One interesting wrinkle in this plan: Borrowers opting for the zero-point, prepayment-penalty concept would pay a lower interest rate than customers choosing standard zero-point loans without prepayment penalties. Standard zero-point borrowers, for instance, might pay 7 3/4% for a loan this month. Borrowers under the new, prepayment-penalty option would get a 7 1/8% note rate.

What if a lender offers you such an option the next time you apply for a mortgage?

Here are a couple of practical guidelines:

--First, if you have any doubt whatsoever that you might want to refinance in the coming three to five years, or if you think rates might fall further, don’t risk the penalty to get the lower rate or fees.

--But if you feel there’s a strong chance you can pass the three- or five-year test, and you’re comfortable with the risk, hey, why not save the money? Just make sure you know exactly what you’re signing up for--the best scenario and the worst.