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

"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.

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Consider these findings from the recent research, Ernst said:

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

• Borrowers with prepayment penalties are 16 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 millions of dollars in home equity-based wealth. This can worsen an already wide wealth gap for African American and Latino families, whose homeownership rates are significantly lower than the rate for white Americans.

But Mitchell Feinstein, chairman of the National Home Equity Mortgage Association, disputes the findings of the two studies. (By the way, the Center for Community Capitalism received financial support from the Center for Responsible Lending.) Feinstein said in an interview that there is a positive benefit to prepayment penalties because the option can lower interest rates for borrowers.

Not so, according to Michael A. Stegman, director of the Center for Community Capitalism.

Stegman said that, based on the center's research, prepayment penalties do not deliver an offsetting benefit in the form of reduced interest rates.

So why should we all care what happens to subprime consumers?

If you're an investor, you should be concerned because the higher risk of foreclosure associated with prepayment penalties means greater investment losses, Stegman points out.

"Policymakers should be concerned because predatory lending is draining homeowner equity and increasing foreclosures and home losses, especially in minority communities, just at the time that national housing policy is attempting to close the minority homeownership gap," he said.

Homeownership has a stabilizing effect on neighborhoods, and that benefits us all. So it is in all of our interests to discourage practices that may cause our neighbors to lose their homes.

Michelle Singletary discusses personal finance Tuesdays on NPR's "Day to Day" program and online at www.npr.org. Readers can write to her at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071 or send e-mail to singletarym@washpost.com. Comments and questions are welcome, but because of the volume of mail, personal responses are not always possible. Please also note that comments or questions may be used in a future column, with the writer's name, unless a specific request to do otherwise is indicated.

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