Posted on: Thursday, February 17, 2005

THE COLOR OF MONEY
Subprime loans can be very costly

By Michelle Singletary

Those of us who live in the high tower of credit worthiness can't imagine not negotiating for the best mortgage loans. We can't fathom not finding lenders willing to cut us a break by eliminating certain fees or expensive loan terms.

But there are two lending worlds — the prime market (people who can get loans at the best rates) and the subprime market (people who are offered loans with higher interest rates than prime or "choice" customers).

True, the subprime lending market has allowed many credit-challenged people and those without a credit history to buy homes. But within the subprime industry are players who prey on these borrowers. They burden them with loan terms that make it difficult for them to ever join the prime market.

Two new studies show that subprime customers often get loans with prepayment penalties, which make refinancing a costly endeavor.

Prepayment penalties increase the risk of mortgage foreclosure in subprime home loans, even after controlling for the borrower's credit score, loan terms and varying economic conditions, according to a new report by the Center for Community Capitalism at the University of North Carolina.

Another report by the Center for Responsible Lending, a North Carolina-based nonprofit research firm and consumer activist group, indicates that 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.

A prepayment penalty is a fee charged when a borrower pays off a mortgage loan before the due date, often to refinance to a more affordable loan. A $150,000 subprime mortgage at 10 percent interest could result in a $6,000 fee for prepaying the loan, according to the Center for Responsible Lending.

These penalties can prevent a family from refinancing.

"Taken together, the research shows (prepayment penalties) are costly, they are applied unfairly, and — given the risk of foreclosure — they are dangerous," said Keith Ernst, of the Center for Responsible Lending, during a teleconference.

In a typical situation, Ernst said subprime borrowers might get into financial trouble that makes them run up credit card debt. To get some relief, home- owners might try to refinance.

"For borrowers with a prepayment penalty, this can be impossible," Ernst said. "If you owe $135,000 and call up for a payoff quote, they are going to tell you $140,000 because that figure includes the prepayment penalty. Once someone hits this roadblock, foreclosure and/or bankruptcy is likely not far off."

In the example Ernst lays out, having to pay the extra $5,000 in a prepayment penalty could eat up much of the homeowner's available equity.

Consider these findings from the recent research, Ernst said:

• Prepayment penalties go disproportionately to borrowers in rural areas and communities with higher concentrations of minority residents.

• Borrowers with prepayment penalties are 16 percent to 20 percent more likely to see their subprime loans fail.

• Despite having a prepayment penalty clause in their loans, 37 percent of all borrowers with prepayment penalties prepaid their loans, resulting in the loss of home equity wealth.

Michelle Singletary writes for the Washington Post