Pick-A-Pay ARMs and Pre-Payment Penalties

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Can a negative amortization mortgage be paid off at any time without prepayment penalties?


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The fact that a loan allows for potential negative amortization does not, in and of itself, determine whether that particular loan can or cannot be prepaid without penalty.

That being said, most negative amortization loan programs (also referred to as Option Arms, Pick-A-Pay-Arms and Payment-Option Arms) had a pre-payment penalty as a feature — I use the past-tense since very few lenders now offer those loans. For example, for loans without a pre-payment penalty a wholesale lender would not pay a commission to the broker. Hence, the broker would offer that loan with two options: “You can elect to have a pre-payment penalty and I’ll be compensated by the lender and I won’t have to charge you "points” or you can pay “points” and get the loan without the pre-payment penalty.“ Similarly, even in situations where no broker was involved, retail lenders would pay their employees higher commissions for neg-am loans with pre-payment penalties.

Unfortunately, the system was abused and many loan officers, whether they worked for brokers or retail lenders, pushed these loans and the attendant pre-payment penalties on people for whom they were not appropriate just so they could cash fat paychecks.

In a perfect world, when someone gets a loan of any kind, their loan officer should tell them whether or not their loan has a pre-payment provision and, at the closing of the loan, that person should carefully check their loan documents to make sure that they’ve been told the truth. In short, if your loan has a pre-payment penalty, you should know about it.

Answered about 6 years ago

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