QUESTION: I read with interest your article on prepayment penalties. My lender is going to hit me with a sizable prepayment penalty, and I would like to refinance the property. What would happen if I simply stopped making payments and allowed the property to go to foreclosure? I then would be able to buy the property back at the foreclosure sale and avoid any prepayment penalties. Of course, it would be necessary to refinance, but at least I could save the steep prepayment.
ANSWER: Foreclosure is never the answer -- under any circumstances.
You have suggested a very ingenious way of attempting to save the prepayment penalty, but I suspect that you will be jumping out of the frying pan right into the fire.
Foreclosure has significant consequences that will follow you the rest of your life. If you try to obtain a loan, now or in the future, the fact that your house was foreclosed on will be a serious detriment to your ability to obtain new financing. As we all know, credit bureaus maintain volumes of information on our personal habits, and no creditor likes to see any problems on a credit report.
There are other problems associated with your proposal. First, there is no guarantee that you will be able to obtain alternative financing, and you may not be able to repurchase your house at the foreclosure sale.
Second, mortgage lenders do not have to foreclose on the property if you are in default on your mortgage payment. Remember that at settlement, you signed two pieces of paper. One was called the promissory note, whereby you agreed to pay the mortgage lender a certain sum in monthly installments that included principal and interest. You also signed a deed of trust, which enabled the lender to put a lien on your property as security for the payment of the promissory note. It is the deed of trust that permits the lender to foreclose.
However, if the lender gets wind of the fact that you merely are trying to avoid the prepayment penalty, it may very well decide to sue you on the promissory note -- rather than foreclose on the property.
I suspect that you will end up paying a considerable amount of money in legal fees to defend your action, and I also suspect that you will owe the lender for its legal fees if it files suit.
Finally, have you given any thought to the costs of foreclosure? In order to foreclose, the lender must direct the trustee to advertise the property in a general-circulation newspaper. This costs a lot of money.
Additionally, the lender is entitled to collect from you all of the other foreclosure costs, including, but not limited to, auction fees, legal fees and trustee's fees.
I strongly suggest that you read the deed of trust that you signed, because that document spells out the various costs for which you would be obligated. It may very well be that the trustee's fees alone will exceed the amount of the prepayment penalty you are trying to save.
No, I cannot recommend foreclosure as an answer to anyone's problems.