The title of this article should spark your interest! You have likely felt the burn of an EPO … and the penalty fees they can impose.
To prevent mortgage portfolio runoff, your investor contracts usually require monetary reimbursement for loans that payoff within the first few months of a loan being purchased (usually within a 6 to 12-month period). These penalties can cost origination-lenders thousands. And if discount points are involved, they can soar!
Now let’s be clear, there is no way to eliminate EPO risks. But there are strategies you can engage to significantly manage them.
Learn how to reduce Portfolio Runoff and EPOs
Why does this happen?
To illustrate, you have spent months working to close a purchase-loan for your borrowers. During this time, the interest rate market may have adjusted. If you change the rate this far into the process, you are basically starting over … disclosing and re-disclosing ad nauseam … and layering extra time burdens. Of course, there are the customary pressures to close. So, the borrowers decide to go with the loan as originally constructed. Another success (so you think).
Competitors will then start bombarding your client with refinance offers. Given the payment shock so many borrowers experience after closing … and all the expenses associated with moving into and furnishing a home … any proposal that suggests payment relief (even the prospects of one or two months of deferred payments) becomes attractive.
They refinance. And you get a gut-wrenching ‘early payoff’ bill!
If rates are currently steady do I still need to worry about EPOs?
Yes! There are all kinds of reasons that motivate borrowers to refinance. Some could be:
Invest proceeds from the sale of an asset to lower the original loan amount and payment.
Pull cash-out for home improvements or debt consolidation.
Migrate from a government insured loan to a conforming loan. (Often driven by improved credit scores.)
Apply enhanced valuation to eliminate MI.
No skin in the game!
The very common origination strategy of lender-paid closing costs greatly amplifies the risk of an EPO. Of course, borrowers are thrilled when they don’t pay most … or even any … of the closings costs and prepaids to get the original loan. But likely not so thrilled that higher than then-market rates (typically .50% or more) were contracted to create the ‘premium’ needed to do this. Depending on rates-movements, a new loan may be available that will reduce their Note rate and still cover costs. With no ‘skin in the game’ beyond signing a few papers, they re-fi.