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Color of Money

Loan Terms Can Make It Hard to Climb Out of the Subprime Pit

By Michelle Singletary
Thursday, February 17, 2005; Page E03

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

Pay a penalty for prepaying a loan? Please. Not likely to happen for a prime-time borrower. There are two lending worlds out there -- 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).

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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 higher-risk borrowers. They intentionally burden their customers with loan terms that make it difficult for them ever to join the prime market.

For example, two new studies show that subprime customers often get loans with prepayment penalties, which make refinancing a very 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 by a lender when a borrower pays off a mortgage loan before the due date, often to refinance to a more affordable loan. For example, 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 effectively prevent a family from refinancing -- something that some prime borrowers seemingly do as often as they change the oil in their cars.

"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, senior policy counsel for the Center for Responsible Lending, during a teleconference.

In a typical situation, Ernst said, a subprime borrower might get into some financial trouble -- a lost job, broken-down car or something else that makes him or her run up a credit card or cards. To get some relief, the homeowner might try to refinance to consolidate debt.

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