Prepayment Penalties Convey No Interest Rate Benefits on Subprime Mortgages
Published: January 13, 2005
Prepayment Penalties Impact Minority Neighborhoods
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For years, subprime lenders have defended prepayment penalties by claiming that borrowers with penalties get a lower interest rate. Now, groundbreaking research by CRL shows that borrowers get no rate benefits with subprime prepayment penalties -- and that residents in minority neighborhoods have much greater odds of receiving such penalties.
Prepayment penalties (fees for paying off mortgage loans early) are almost nonexistent in the prime mortgage market, but occur in up to 80% of subprime mortgages. The costs of these fees can prevent refinancing or strip equity, widening an already vast wealth and homeownership gap between white families and African-American and Latino families.
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1. Borrowers in minority neighborhoods face greater odds of receiving a subprime prepayment penalty by a statistically significant margin.
In high minority communities, borrowers face 35% greater odds of receiving a prepayment penalty with a term of two years or more, compared to residents in zip code areas with a "low" concentration of minority residents. For borrowers in medium-high minority areas, the odds of receiving prepayment penalties of two years or more is 10 percent greater than that of similarly situated borrowers in low minority areas.
2. Contrary to claims that borrowers get a lower rate on loans with prepayment penalties, we find that subprime prepayment penalties provide borrowers with no interest rate savings.
For subprime refinance loans, prepayment penalties produced no meaningful difference in borrowers’ interest rates. For subprime purchase loans, borrowers who had loans with prepayment penalties paid higher interest rates than similarly situated borrowers who had loans without prepayment penalties. For an estimated 380,000 borrowers that received subprime purchase loans in 2003, the lifetime cost of this higher interest rate is up to $881 million.