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Group Says Prepayment Penalties Worse for Minorities

Group Says Prepayment Penalties Worse for MinoritiesCenter for Responsible Lending report looks at neighborhood disparities

January 17, 2005


Subprime borrowers living in minority neighborhoods are more likely to receive abusive prepayment penalties on their loans than those living in mostly white neighborhoods, according to new research from a fair lending advocacy group.

Those were the main findings in the latest studies by the Center for Responsible Lending announced Thursday. The discrepancy found amongst subprime borrowers in different neighborhoods was based on an analysis of 1.8 million loans originated from January 2000 to July 2004, while the effects of prepayment penalties on interest rates were based on an examination of 30-year fixed-rate loans originated during a three-year period, the group said.

The subprime industry, which lends to borrowers who do not qualify for lower-rate prime loans, claims prepayment penalty terms benefit borrowers in the form of a lower interest rates, according to CRL.

The research found, however, that subprime borrowers “burdened” with prepayment penalties actually pay higher interest rates on their purchase loans than similar borrowers without prepayment penalties, and that they do not receive “meaningful interest rate reduction when they choose to refinance,” CRL reported.

The group found that 30-year subprime purchase loans with prepayment penalties carried an interest rate 40 basis points higher than would otherwise be expected — resulting in an estimated cost of $881 million in extra interest over the life of such loans.

The “findings are shocking,” said CRL president Mark Pearce in the announcement. “Not only do prepayment penalties lock borrowers into the higher-cost subprime market or force them to give up the wealth they have built through homeownership, but they also turn out to offer no benefit to borrowers in the form of lower interest rates, as the subprime industry has claimed.”

But the trade group representing the nation’s nonprime lenders disagrees with such findings. “Non-prime mortgage lenders have been working for years to end the vestiges of redlining and give every American an opportunity to get a mortgage,” said Mitch Feinstein, president of NHEMA, in a written response to a similar study last year by the Association of Community Organizations for Reform Now, or ACORN.

“We welcome any ideas from consumer advocates and others about how to enhance protections for vulnerable consumers and how we can get mortgages to more people, more efficiently,” Feinstein added. “It’s disappointing, however, when a group that claims to represent consumers releases yet another report that uses flawed data to advance its view that only those who meet the strict criteria for prime loans should be able to get a mortgage.”

That announcement went on to say that the report by ACORN, a consumer advocacy group, avoided “key HMDA statistics showing that the ethic distribution of non-prime mortgage loans — 68 percent white, 14 percent Hispanic, 12 percent African-American and 6 percent Asian and other — almost precisely mirrors America’s overall demographic breakdown.”

ACORNs latest report on the subprime lending market showed this type of higher-cost lending continues to disproportionately plague low-income people and minorities.

Subprime loans account for one-fifth of all mortgages and nearly 80% of subprime loans have prepayment penalties, in contrast to only 2% of mortgages in the prime market, according to the CRL.

A typical penalty is equal to six months’ interest on any prepayment greater than 20 percent of the mortgage balance. A $150,000 subprime loan at a 10% interest rate could result in a prepayment penalty fee of $6,000, the announcement said.

“These abusive prepayment penalties operate as a hidden fee that disproportionately affects both rural and minority neighborhoods,” CRLs Pearce said.

The cost of such fees can prevent a family from refinancing or are paid directly from equity — each year, prepayment in subprime loans cause 850,000 families to lose $2.3 billion in home equity wealth, according to CRL. The costs further worsen “an already wide wealth and ownership gap,” the group added, noting that African-American and Latino families have a median net worth of $5,998 and $7,932 respectively, compared to $88,651 for whites.

“The evidence is now clear,” said Hilary Shelton, a director for the National Association for the Advancement of Colored People, in the announcement. “Prepayment penalties in subprime loans are locking African-American families out of the prime mortgage market and rolling back hard-earned economic progress.

More than 35 states regulate the use of prepayment penalties in home loans, CRL said, and at least nine states do not permit them.

Coco Salazar is an assistant editor and staff writer for

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