Can I get around a prepayment penalty? - Posted by Lisa Dassie

Posted by Rob FL on December 20, 1999 at 12:59:23:

Several lower court cases have declared prepayment penalties which do not allow for the sale of the property as an “unfair trade practice” and “unlawful constraint on the alienation of property.” That is why the standard prepayment clauses for FNMA/FHLMC make an exception for the sale of the property.

Can I get around a prepayment penalty? - Posted by Lisa Dassie

Posted by Lisa Dassie on December 20, 1999 at 11:33:56:

I have the opportunity to buy a house “subject to” but it has a prepayment penalty with the 24 months and they’re at 6 months. The penalty is 6 month interest. The ARV on the house is 150K while the loan balance is 117K. It needs about 10K in work but I was thinking of flipping to a rehabber. Is there a way around the penalty?

Re: Can I get around a prepayment penalty? - Posted by Rafael_FL

Posted by Rafael_FL on December 20, 1999 at 23:24:28:

Another thing you might want to check is to see if the loan was originated by one company, then sold to another. My 2 yr ARM had a 2 yr prepayment penalty on it. 2 months later my loan was sold to the Money Store. I just assumed that the prepayment penalty stayed in effect. I found out Friday that there is no prepayment penalty. I could have done a refi a year ago.

Re: Can I get around a prepayment penalty? - Posted by Glenn

Posted by Glenn on December 20, 1999 at 16:29:29:

Consider a PACTrust to take care of the prepayment penalty. You also may even be able to find a tenant/co-beneficiary who would do the re-hab work on ‘their’ house. You wouldn’t get an immediate return, but getting future payments on a property you don’t own would be OK.
See to find out about the PACTrust.

Re: Can I get around a prepayment penalty? - Posted by JohnBoy

Posted by JohnBoy on December 20, 1999 at 12:55:21:

Even if you could avoid the pre-pay penalty there isn’t enough room to flip to a rehabber. ARV is $150k. The amount owed is $117k plus $10k in repairs. $150k - $127k = $23,000 to work with.

Back out the realtors commission the rehabber would pay to resell at retail and that knocks another $9k off. Then figure another 3 - 6 months holding costs for the rehabber to fix and market to sell. Back out your cut on the deal. By the time you back out all of the expenses the rehabber is lucky to break even. A rehabber would probably expect to NET $20k minimum after all expenses on a property like this.

The way to do this deal is on a Lease Option or a Land Contract with the right to assign. Tie up the deal, then assign your contract to a retail buyer that will live in the house and take care of all the repairs. You could assign your contract for a quick $5k - $10k and walk away.

Or if you want to stay in the deal for awhile lease option it or sell on contract to someone else.

Another way to do it is just assume the sellers loan “subject to”. You take over the payments leaving the current loan in place while the seller deeds the property over to you. You become the legal owner without liability on the loan. Next you l/o to your tenant/buyer or sell to them on a land contract for $150k “as is” making them responsible for all the repairs. Get $5k - $10k down as “non-refundable option consideration” if you l/o it or $5k - $10k down as a down payment if you sell on contract.

Before approving your tenant/buyer, take their credit app. to a good mortgage broker to see about getting them financed in 18 months to 2 years from now.

After making payments for 18 - 24 months getting past the pre-payment penalty you get them refinanced for 80% - 90% LTV (loan to value)and you carry back a second.

Lets say you found a buyer that had $10k to put down. Since your willing to carry for 2 years on terms, you sell for the $150k ARV “as is” on contract or a l/o. (Lots of people out there would gladly pay market value if they can get in with good terms) At the end of 2 years your buyer has done most of the repairs if not all of them and the property would appraise for more providing the market holds up over the next 2 years.

Your buyer needs to come up with $140k to refinance in order to pay you off. Lets say the property only appraises for the $150k in 2 years from now. Your buyer is able qualify for a mortgage at 90% LTV. 90% of $150k is $135k. You get $135k at closing. $117k goes to pay off the underlying loan you assumed “subject to” leaving $18k in your pocket. Your buyer still needs to come up with $5k that you agree to carry back as second mortgage. You made $10k up front, $18k at closing, a second mortgage of $5k, plus any positive cash flow you got over 2 years from your buyers monthly payments that exceeded your payment on the current loan you took over.

You didn’t say what the current payments are on the existing loan. Simply adjust the interest rate to your buyer based on $140k amortized over 30 years to reflect the amount of positive cash flow you get each month. Of course the payment has to be affordable and inline with what you can reasonably expect to collect based on the market in your area.

Lets assume for an example that the current loan is at a 9% interest rate on $117k. The principle and interest payment would be $941.41 per month plus taxes and insurance. At the end of 2 years the balance owed on this loan would be $115,326.28 (Read the mortgage agreement the seller has to determine the accurate interest and payments on the loan)

You sell for $150k with $10k down leaving a balance of $140k. You sell on contract and amortize the $140k over 30 years at 10.5% interest (10.5% interest on a land contract is pretty standard, at least in my area it is) with a 2 year balloon plus taxes and insurance. Your buyers principle and interest payment to you would be $1280.64 plus taxes and insurance. You collect a positive cash flow of $339.23 for 24 months.

At the end of 24 months when the balloon comes due and your buyer needs to refinance to pay you off the principle balance owed would be $138,521.33

They get a loan for 90% LTV based on $150k appraisal = $135k. (If the property appraises higher then you may get completely cashed out at closing. If not, then carry a second for the difference. Its all extra free money to you!)

$135k - your pay off of $115,326.28 = $19,673.72 cash in your pocket at closing!

You make $10k up front, $8,141.52 cash flow over 24 months, $19,673.72 at closing when your buyer refinances, and a second mortgage amortized over 5 years at 14% for $3,521.33. That’s $81.94 for 60 months = $4,916.40

$10,000.00 up front
$ 8,141.52 monthly cash flow over 2 years
$19,673.72 cash at closing
$ 4,916.40 in payments on a five year second mortgage

$42,731.64 total profit!

Tie up the deal and try to get 60 days before you start making payments. This gives you 2 months to market the property and lock up a buyer.

Go for it!

Re: Can I get around a prepayment penalty? - Posted by Stacy (AZ)

Posted by Stacy (AZ) on December 20, 1999 at 12:07:28:

Lisa, make sure to read the terms of the prepayment penalty. Many times, if the house is sold (deed to new buyer), the prepayment penalty doesn’t apply. In other words, if a new buyer pays off the existing loan, either through a new loan, or with cash, the prepayment penalty may not apply.

Might be worth a look.


Did you mean what you said? - Posted by Bud Branstetter

Posted by Bud Branstetter on December 20, 1999 at 12:25:42:

Your last statement was that if a new owner paid off the existing loan then the prepayment would not apply. Or did you mean that the prepayment would apply if paid off early. The lender may not have added his fees up front so he wants to earn a certain(usually higher)amount for a time and wants a penalty to make up for the lack of higher interest. More likely in this case is taking the house subject to and continue making the payments. The difficulty I see is with a 117K balance, 10K in rehab, finders fee and 1K+ payments an investor is not likely to see enough profit potential for the risk.

Re: Did you mean what you said? - Posted by Stacy (AZ)

Posted by Stacy (AZ) on December 20, 1999 at 12:33:50:

Hi Bud!

Yes I think I said it right. For example, I have a 5 year prepayment penalty on the mortgage on my own home. It is specifically stated in the prepayment penalty rider that if my home is sold, the prepayment penalty does NOT apply.

So, in the example, if she takes over the property subject-to, rehabs a little, and then resells to a new buyer who will either get a new loan or pay-off the underlying mortgage(s), the prepayment penalty MAY not apply.Then again, the prepayment penalty may very well apply, but it’s worth checking the terms to see if this is the case.

Make sense?


I’m a little slow… - Posted by Rich

Posted by Rich on December 20, 1999 at 12:43:50:

but I don’t understand why you would have a 5 year prepayment penalty and then be able to avoid it by selling your home. Isn’t that the purpose of a prepayment penalty - to insure the lender that they will get what’s coming to them. Usually they give you a better rate up front knowing you are essentially locked in for at least 5 years. But if you sell, then the penalty comes into play. Now, if you get someone to assume the loan (without the bank’s knowledge), that would be a different story. That’s always been my understanding, but as I said in the beginning…I’m a little slow.

Re: I’m a little slow… - Posted by Stacy (AZ)

Posted by Stacy (AZ) on December 20, 1999 at 12:54:12:

The purpose of this prepay rider was to help ensure that I wouldn’t refinance to a lower interest rate for 5 years. In return, my initial interest rate was reduced. However, if I sell to a new buyer and pay-off the loan, there is no penalty. Don’t know what to tell you…it’s a standard program through Countrywide.