Billionaire hedge fund manager Bill Ackman’s call for Fannie Mae and Freddie Mac to offer new government‑backed mortgages with prepayment penalties put a spotlight on how much United States borrowers have paid for the right to refinance at will.
Ackman wrote “One of the unique features of U.S. conventional mortgages is that they are prepayable at any time without a penalty. While this feature is attractive for homeowners, it comes at a significant cost as buyers of mortgage-backed securities (‘MBS’) require a significant increase in spread to compensate them for giving the borrower the option to prepay at any time.”
He said an MBS investor has estimated that shifting to a structure with penalties could cut the rate on a standard 30‑year Fannie or Freddie loan by about 65 basis points, giving borrowers a choice to “obtain a 30-year prepayable mortgage at today’s ~6% rate, or at a 5.35% rate, but with the obligation to pay a prepayment penalty if he/she refinanced in the future.”
With over 20 years of experience in mortgage loans, I have found that prepayment penalty loans often lead to some of the worst outcomes. These penalties tend to benefit large investors but are detrimental to American homeowners.
For example, if your $400,000 loan at a 5.375% fixed rate for 30 years comes with a 5-year prepayment penalty of 3% or 6%, that’s generally a favorable rate. However, should interest rates drop considerably within those five years, you could face $12,000 to $24,000 in penalties just to refinance early. Similarly, if you need or want to sell your home during that period, you will incur the same prepayment charges.
There was a strong reason why prepayment penalties were discontinued on qualified mortgages. Let’s hope they do not come back.
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