By Gina Pogol
Mortgage Credit Problems Columnist

Dear Gina, I have a bad credit mortgage with a prepayment penalty that is keeping me from refinancing. I read that new laws made it illegal to have prepayment penalties now. Does this mean the penalty on my loan can no longer be enforced? - Bob, Casa Grande, Ariz.

Dear Bob,

Recent mortgage reforms did not make prepayment penalties illegal on bad credit mortgages or on any mortgages. What they did was to restrict the conditions under which a mortgage with a prepayment penalty can be offered or sold to a borrower.

The Mortgage Reform and Anti-predatory Lending Act restricts such penalties as follows:

A lender may not impose the penalty on loans that have adjustable rates or have an annual percentage rate (APR) that exceeds certain thresholds (like many bad credit mortgages do).

For loans that qualify to have prepayment penalties, there are further restrictions:

• During the first-year period beginning on the date the loan is consummated, the prepayment penalty may not exceed an amount equal to 3 percent of the outstanding balance on the loan.
• In the second year from the date the loan is consummated, the prepayment penalty may not exceed an amount equal to 2 percent of the outstanding balance on the loan.
• In the third year from the date the loan is consummated, the prepayment penalty may not exceed an amount equal to 1 percent of the outstanding balance on the loan.
• After the end of the three-year period beginning on the date the loan is consummated, no prepayment penalty may be imposed on a qualified mortgage.

If your loan's prepayment penalties exceed these restrictions, it would not be legal under the new law. However, the law is not retroactive; it does not apply to loans that are already funded and in compliance with applicable law.

There is one more piece of this law regarding prepayment penalties. A lender may not offer you a mortgage product that has a prepayment penalty without offering you one that does not have a prepayment penalty as a term of the loan. This ensures that bad credit lenders can't force you into a prepayment penalty -- you will have the opportunity to get a loan that doesn't have one.

Why would you ever choose a loan with a prepayment penalty? Well, there is no reason to opt for a loan with a prepayment penalty unless you get something in return. Usually, lenders offer a lower mortgage rate to those borrowers who are willing to commit to holding the loan for a period of time. However, those with bad credit mortgages should not plan to hold them any longer than necessary. That is, bad credit mortgages should not be held longer than it takes to improve your credit and qualify for a prime mortgage.

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