Pre-Payment Penalties - The Bigger Picture

This is a "sidebar" to " Of Pools and Puddles... "

Good or bad.
Right or wrong.
Black or white.

I know what your thinking, "There's no black or white about it. A pre-pay is a pre-pay."

Ask a room full of consumers, "Why do some loans have a PrePay?" and they'll pretty much all agree.

"Pre-Pays are for suckers. Those Lenders just want to make extra cash from us!"

Go ahead and tell someone at a BBQ that your loan has a Pre-Pay, I dare you!
You fear being an outcast right?
Visions of your own brother in law, Bradley "The Know It All" pelting you from 25 feet with overcooked hamburger patties?
Owwww!

Take a step back from the consumers point of view.
Then another and another. Keep going....
Far enough back yet?

Where does mortgage money come from?

"Duh Mike, the Lender."

Ok, I'll play. Where does the Lender get the money?

"Uhhh, the vault?"

No, let's just say the money comes from Wall Street. (those big guys)

Mortgage money mostly comes from large institutional investors that buy large pools of loans from lenders, warehouses, and pooling institutions.

As an investor, with the choice of two almost identical pools of loans to buy, let's play.
Which one would you buy?

• Pool A - is a billion dollars worth of 680+ credit score, full doc, 80% or less CLTV, Single Family Residences all with 30 yr fixed notes at 6.5%

• Pool B - is a billion dollars worth of 680+ credit score, full doc, 80% or less CLTV, Single Family Residences all with 30 yr fixed notes at 6.5% - and each one has committed to keeping the loan for at least 3 years.

Which one has more value to you the investor? The ones with the pre-pay right? - That was easy, eh?
Why? Because the investor has confidence the Pool Dwellers in B are going to keep on sending them checks for a long time to come.
If they decide to sell or refi - they'll still get a check (the pre-pay).
That makes for a better Return on their Investment (ROI)

To even things up, what if now Pool B was at a slightly lower interest rate than Pool A?
You could see there would be a point when both Pools might have the same value to the investor but carry different interest rates.

Now let's switch back to the role of the consumer.
You just asked for a 30 year fixed loan because you said you wanted stability and were going to live in this house forever.

Your mortgage professional presented you with two almost identical 30 yr fixed programs, except one has a pre-pay and a better rate.
(This isn't always the case. Sometimes their isn't the ability to accept a commitment period in lieu of a better rate.)
But let's just say that this time there was.

A couple of years from now did it matter that you had a pre-pay?
Did it cost you any more to have a pre-pay?
Actually not, it probably saved you money!

It's all about perspective. Stepping back and seeing the big picture.
Or stepping back and letting a Braut fly, beaning poor Bradley in the back of the head, knowing your rate is lower than his, and knowing why!

Perspective.