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Subprime Prepayment Penalties Impact Minority Neighborhoods, Provide No Interest Rate Benefits

Thursday, January 13, 2005

Download the Reports

Borrowers in Higher Minority Areas More Likely to Receive Prepayment Penalties on Subprime Loans (PDF 364kb)

Prepayment Penalties Convey No Interest Rate Benefits on Subprime Mortgages (PDF 351kb)

DURHAM, N.C. -- People with subprime home loans who live in minority neighborhoods face 35 percent greater odds of being saddled with prepayment penalties than borrowers living in predominantly white neighborhoods, according to new research from the Center for Responsible Lending (CRL). Also today, CRL reports findings -- in direct contradiction to subprime mortgage industry claims of homeowner savings -- that borrowers burdened with prepayment penalties actually pay higher interest rates on subprime home purchase loans, and receive no meaningful interest rate reduction when they choose to refinance.

"The evidence is now clear. Prepayment penalties in subprime loans are locking African-American families out of the prime mortgage market and rolling back hard-earned economic progress," said Hilary Shelton, Director of the NAACP Washington, DC Bureau. "Today's report provides more empirical evidence that African-Americans are second-class citizens in the subprime market, and that skin color determines the terms of credit that a family receives. Clearly, there is a dire need for reform to curtail these discriminatory and injurious practices."

CRL president Mark Pearce said, "These findings are shocking. Not only do prepayment penalties lock borrowers into the higher-cost subprime market or force them to give up the wealth they have built through homeownership, but they also turn out to offer no benefit to borrowers in the form of lower interest rates, as the subprime industry has claimed. These abusive prepayment penalties operate as a hidden fee that disproportionately affects both rural and minority neighborhoods."

CRL found that 30-year subprime purchase loans with prepayment penalties carried an interest rate 40 basis points higher than would otherwise be expected. Applying CRL's research findings to 2003 subprime purchase loans, researchers estimated that during the life of these loans, Americans will pay up to $881 million in extra interest on purchase loans with prepayment penalties.

A prepayment penalty is a fee charged by a lender when a borrower pays off a mortgage debt prior to the due date, often to refinance to a more affordable loan. A typical penalty is equal to six months' interest on any prepayment greater than 20 percent of the mortgage balance -- a $150,000 subprime mortgage at 10 percent interest could result in a $6,000 fee for prepaying the loan, for example. Because the cost of these fees can prevent a family from refinancing or are paid directly from equity, they worsen an already wide wealth and ownership gap, further distancing African-American and Latino families who have a median net worth of $5,998 and $7,932 respectively, compared to $88,651 for whites.

Prepayment penalties are evidenced in 70 to 80 percent of all subprime home loans, while almost nonexistent in the prime mortgage market. Since subprime lending now accounts for one out of five mortgage loans, the different practices in the subprime market come at a staggering cost. Policymakers have recognized the negative effects of prepayment penalties as more than 35 states regulate their use in home loans, and at least nine states ban them outright. In the grimmest scenarios, abusive prepayment penalties result in severe financial losses for families or even worse, foreclosure.

About the Data and Methodology

Both research reports, "Borrowers in Higher Minority Areas More Likely to Receive Prepayment Penalties on Subprime Loans" and "Prepayment Penalties Convey No Interest Rate Benefits on Subprime Mortgages" use multivariate regression models to analyze data from Loan Performance, Inc. The reports utilize subsets of 1.8 million and 0.5 million loans respectively.

Additional Information

A report addressing the prevalence of prepayment penalties among rural borrowers ("The Geography of Subprime Mortgage Prepayment Penalty Patterns" released in Fall 2004, Housing Policy Debate).

Contact: Sharon Reuss at 919-313-8527 or sharon.reuss@responsiblelending.org