A prepayment penalty is a financial limitation placed on a mortgage limiting a borrower's ability to prepay his loan earlier than specifically allowed under the terms of his agreement. Prepayment penalties place financial disincentives on borrowers securing alternate loans to repay their existing loans, and as such, refinancing loans to pay off existing loans is financially difficult. Under federal law, mortgage loan lenders are specifically authorized to charge their customers prepayment penalties.
The Code of Federal Regulations does not limit the amounts and types of prepayment penalties lenders can charge. In light of the federal statutes, state laws cannot preempt the federal statutes. However, state laws can limit prepayment penalties for high-cost loans, as long as states do not place a blanket prohibition on prepayment penalties.
California law allows lenders to charge prepayment penalties, since the state legislature is preempted from enacting blanket prohibitions by the Code of Federal Regulations. Although California law allows mortgage lenders to charge prepayment penalties to discourage borrowers from paying off their loans earlier than the duration of their mortgage notes, lenders must comply with the state licensing laws and must provide written disclosures regarding prepayment penalties. Generally, California lenders can use prepayment penalty provisions if the assessed penalties apply to the first five years of their mortgages. After five years, lenders are limited from assessing prepayment penalties.
California Financial Code
California's predatory lending regulations are codified in the California Financial Code and apply to mortgage loans. The predatory lending laws do not apply to high-cost loans or loans of short duration. High-cost loans are those that exceed $250,000. Short-term housing loans are those that require mortgage lenders to provide written disclosures to consumers entering into high-cost loans that mature in one ear or less. They also do not apply to loans used to purchase rental property or reverse mortgage transactions.
Lenders providing high-cost loans to consumers must provide them with written prepayment penalty disclosures pursuant to the California Financial Code. If the California predatory loan laws apply to consumers' loans, lenders cannot charge prepayment penalties for the first three years, and lenders cannot increase their assessed interest penalties upon default.
In California, the Department of Corporations regulates financial mortgage lenders pursuant to the California Residential Mortgage Lending Act. The California Residential Mortgage Lending Act is codified in the California Financial Code and became effective in 1996. The act regulates the licensing requirements and the lending practices of loan originators and servicing companies. Additionally, the California Department of Real Estate is responsible for regulating the California Real Estate Law, and the department regulates the disclosure requirements for home lenders. Pursuant to the licensing regulations, California lenders can face fines of up to $25,000 and can face licensing revocation by the California Department of Real Estate.
Since state laws can frequently change, do not use this information as a substitute for legal advice. Seek advice through an attorney licensed to practice law in your state.