Mortgage prepayment fees limited

Emergency rule prohibits penalty after loan rate resets; it's intended to slow foreclosures

By James Paton, Rocky Mountain News (Contact)

Published December 18, 2007 at 12:05 a.m.

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Photo by Joe Mahoney / The Rocky

Erin Toll, director of the Colorado Division of Real Estate, calls the increase in mortgage foreclosures a "crisis."

With foreclosures at record levels, a Colorado regulator has tackled prepayment penalties that can trap borrowers in costly mortgages.

Erin Toll, director of the Division of Real Estate, has adopted an emergency rule restricting the penalties, implementing laws signed in June by Gov. Bill Ritter.

The measure, which took effect Friday and was announced Monday, prohibits fees that extend past the dates loans are adjusted to higher interest rates.

It is billed as a step to try to stem the rising tide of foreclosures. Colorado is bracing for 37,000 foreclosures in 2007, a 30 percent jump from 2006.

"Prepayment penalties are fueling what we're seeing, particularly in lower-income markets," Toll said. "Those are the folks who are most susceptible to the lure of an extremely low rate. What they don't realize is that the monthly rate will double, if not triple, if not quadruple, in the near or far future, and when it does, they are left without any option."

Borrowers often are enticed with adjustable-rate mortgages that initially have low monthly payments. In exchange, they face charges for early payment. But critics have said that the stiff penalties make it difficult for homeowners to refinance into more affordable loans or to sell their properties when the interest rates increase. The result can be a foreclosure.

"This is a good start," said Jim Spray, a mortgage broker who sits on a task force advising the real estate division. "It should provide some measure of confidence for consumers that there really are people out there with their best interests in mind."

Spray said the significant penalty, typically six months' interest, is rarely the sole factor driving people into foreclosure. But he said the new rule is important because "it's a fairness issue."

"Even if we're helping one family, we've got to do it," he said.

Consider an example: A borrower paying $1,500 a month may see his expense rise to $1,750, and later to greater payments, as his interest rate adjusts. Spray said a homeowner might be able to refinance, but that could trigger a penalty of $7,500 to $9,000 he cannot afford. So, the borrower has a dilemma. From now on, the prepayment penalty will last only as long as the introductory period.

Chris Holbert, president of the Colorado Mortgage Lenders Association, said, "We understand the interest in protecting consumers and the division's response, but it's an issue the markets for the most part already have addressed."

"It would be difficult, though not impossible, to find a loan product today that has a prepayment penalty" extending past the adjustment date.

Toll, who took over the job last year, has been aggressive in fighting mortgage fraud and what she calls a foreclosure "epidemic."

In a phone interview Monday, Toll said she was opening an office in Pueblo, where the foreclosure rate has been troubling.

Ritter earlier this year signed a handful of bills into law - including one to license mortgage brokers - aimed at confronting the foreclosure wave.

In a news release announcing the new rule Monday, the governor cited concerns that prepayment penalties were leading to even more foreclosures across the state.

It's Toll's job to interpret, clarify and implement the new laws.

An "emergency" rule is issued by the regulator rarely, when "there's an immediate danger to the public," Toll said.

"And we've been able to meet that standard. This is a crisis."

Help for the homeowner

The laws have passed. Now, Erin Toll, director of Colorado's Division of Real Estate, is implementing them to confront a troubling surge in foreclosures. The latest step: a new rule aimed at "prepayment" penalties.

* What the rule does: Prohibits prepayment penalties that extend past the adjustment date of an interest rate and clarifies and enforces legislation passed by the governor earlier this year.

* When it took effect: Friday.

* Why observers say it's important: Borrowers go for adjustable-rate mortgages with initially low payments. But when the rates rise, owners can run into steep penalties if they want to pay off their loans by selling their properties or refinancing.

• December 19, 2007

  4:43 a.m.

  Suggest removal

  gwats writes:

  You fools need to stop and smell what you are shoveling. These terms were clearly written into the mortgage contracts and the anal retentive types who signed these deals knew the pitfalls when they put their 'John Hancock' on the dotted line. They gambled and they lost. Some of these people are so irresponsible that if you gave all of them a fixed-rate refi, 80% would default on those loans as well.
  Time to cull the herd. Only the strong survive. The rest are subsisting on various forms of welfare.

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