Magazine article American Banker

Subprime Lenders Use Prepayment Fees to Protect Their Portfolios

Magazine article American Banker

Subprime Lenders Use Prepayment Fees to Protect Their Portfolios

Article excerpt

The one-two punch of increased competition and falling interest rates has subprime lenders scrambling to retain loans in their portfolios.

Many say that the best way to stop subprime borrowers from refinancing their loans is to impose prepayment penalties.

"We've been very proactive in ensuring that our products carry prepayment penalties," said David Kiser, investor relations officer for Southern Pacific Funding Corp., Lake Oswego, Ore.

About 70% of the company's loans carry a hefty prepayment penalty-six months' interest on 80% of the balance of any loan refinanced within 18 months after it was granted. This equals five or six points on a loan, Mr. Kiser explained.

Southern Pacific also stays away from excessively "teased" products, Mr. Kiser said, referring to loans that start at a super-low interest rate, then jump up sharply.

Prepayment fees aren't the answer for everyone, said Brian Chisick, president of First Alliance Corp., Irvine, Calif. "Where at all possible, we have prepayment penalties," he said, "but it doesn't do a heck of a lot."

Subprime borrowers are demand borrowers, Mr. Chisick explained. They will refinance when they need the money to pay off debts, regardless of the cost.

When a First Alliance borrower wants to refinance with another company, First Alliance turns over the loan to its portfolio protection division, Mr. Chisick said. The division tries "to give our customer a better deal than they are being offered."

First Alliance loans are especially vulnerable to refinancing because more than three-quarters are at adjustable rates and the company's loans are for less of the home's value than most of its competitors allow. …

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