A recent report in the New Orleans City Business discusses penalties assessed to borrowers who are paying off the mortgage early with received insurance funds.

Some New Orleans-area residents whose homes were destroyed by Hurricane Katrina are discovering an unexpected cost to receiving an insurance settlement.

Residents using settlements to pay off mortgages may be socked by penalties running into the thousands of dollars. Mortgage companies are penalizing the homeowners because they are paying off their mortgages too early.

“My mortgage company, (Cleveland-based) National City Mortgage told me that I could use the money from my insurance to pay on the mortgage but there will be a penalty of 30 percent of the interest they will lose out on,” said St. Bernard Parish resident Melissa Sass, whose mortgage loan carries a 10-year prepayment clause, meaning she can be penalized if she pays off the loan within 10 years.

“They told me that the only way I can pay off my mortgage in full without the penalty is to wait for that 10-year period.”

Loan contract prepayment clauses usually state the borrower will pay a penalty if the loan is paid off within a certain period. Penalties usually involve a percentage of the outstanding balance or a certain amount of the monthly interest lost by paying the balance early.

According to a spokesman for Attorney General Charles Foti, Louisiana residents have paid penalties as high as $14,000 for paying off mortgage loans in the wake of Katrina. The fees are legal because they are part of the original loan contract, they said.

According to National City Mortgage officials, however, Sass was mistakenly assessed a prepayment penalty. If she paid off her mortgage, she wouldn’t be charged a penalty, they said.

“We have relatively few loans that have prepayment penalties in the first place,” said NCM spokesman Chris Kemper. “For hurricane victims, we are pretty much waiving prepayment penalties across the board.”

Subprime loan penalties

A common prepayment penalty is the equivalent of six months interest if a loan is paid off within two years. On a $115,000 mortgage loan at 8 percent interest, the prepayment penalty would be about $5,000.

Prepayment penalties typically are found with the subprime loans often given to people with blemished credit, bankingindustry officials say. Traditional mortgages typically don’t carry prepayment penalties, officials said.

“Most likely, this is something that is happening with mortgage companies rather than traditional banks,” said Peter Gwaltney, CEO of the Louisiana Bankers Association. “I could not imagine a Louisiana commercial bank charging a prepayment penalty under these circumstances.”

Banks avoid prepayment penalties because it is viewed as a predatory-lending practice, Gwaltney said.

However, mortgage lenders are caught between borrowers and Wall Street, industry officials say. While traditional mortgage lenders such as Washington, D.C.-based Fannie Mae and rival Freddie Mac raise money by selling government-backed securities, subprime lenders sell their own securities. These securities generally pay higher returns because the risk is greater.

“These guys are required to pay the bondholders the return on the bond investment,” said Bruce Coffman, president of the Louisiana Mortgage Lenders Association. “They couldn’t begin to consider not meeting their obligation to the bondholders or they would be out of business.”

When someone pays a loan off early, Coffman said, the mortgage company receives a minimal return. However, it is still required to pay premium interest rates on the bonds sold to finance the mortgage.

“They have to pay the bondholders so they are funding that shortfall out-of-pocket,” Coffman said. “If you are talking about $100 million worth of bonds, the shortfall that has to be made up by the mortgage company can run into millions of dollars. They can get coldhearted real quick.”

Penalties waived

Many Katrina victims report their mortgage companies aren’t assessing prepayment penalties.

“I have a mortgage with HSBC Mortgage Services (a division of Prospect Heights, Ill.-based HSBC Bank) and immediately after the storm I called to see if I was going to be penalized for paying off my mortgage early,” said St. Bernard resident Heather LaBauve. “They told me that since this was a national disaster per the president and I did not choose to move or lose my house, that they are waiving the prepayment penalties.”

HSBC officials confirmed they would not charge prepayment penalties on mortgages in areas affected by Hurricane Katrina.

To view the online report please click on the following link:

New Orleans City Business Report Borrowers Assessed Penalties