ANALYSIS: Credit unions sometimes ask whether they can charge prepayment penalties on loans. Sometimes this may be allowed, at least for state-chartered credit unions, but it depends on the type of loan. This Courier summarizes state and federal laws that may limit, or prohibit, the credit union’s ability to charge such penalties.
Federal credit unions vs. state-chartered credit unions
The Federal Credit Union Act (12 U.S.C. 1757(5)) bars federal credit unions from charging prepayment penalties. It says:
(viii) a borrower may repay his loan, prior to maturity in whole or in part on any business day without penalty, except that on a first or second mortgage loan a Federal credit union may require that any partial prepayments (I) be made on the date monthly installments are due, and (II) be in the amount of that part of one or more monthly installments which would be applicable to principal.
Section 701.21(c)(6) of the NCUA Regulations implements this ban on prepayment penalties, saying: “Early payment. A member may repay a loan, or outstanding balance on a line of credit, prior to maturity in whole or in part on any business day without penalty.”
However, neither that NCUA rule nor that provision of the Federal Credit Union Act applies to state-chartered credit unions, even if they are federally insured. Part 741 of the NCUA rules has a laundry list of NCUA regulations that apply to federally insured, state-chartered credit unions in addition to FCUs. That list does not include §701.21(c)(6).
Various federal laws
Federal laws may limit or bar prepayment penalties on certain loans. These laws make no distinction between FCUs and state-chartered credit unions. This is not meant to be an exhaustive list, but federal limits include these:
- Reg. Z and the federal Home Ownership & Equity Protection Act (HOEPA) bar prepayment penalties for “high cost” mortgage loans. See The League’s ii Release No. B062.
- Under the federal Military Lending Act, a credit union cannot prohibit a covered borrower from prepaying a covered loan or charge a prepayment penalty. The rules prohibit loan agreements that include prepayment penalties and certain other provisions, such as arbitration clauses. See The League’s ii Release No. B067.
- Reg. Z imposes several restrictions on “higher priced mortgage loans,” meaning any closed-end mortgage loans to consumers that are secured by the consumer’s principal dwelling, if the APR is greater than certain tolerances. Among the restrictions, prepayment penalties are prohibited if the payments on a higher-priced mortgage loan can change during the first four years after the loan is made. Even if payments cannot change, a prepayment penalty may only be assessed for two years after the loan is made and only if another applicable law permits the penalty. See The League’s ii Release No. B068.
- Reg. Z bars prepayment penalties or fees for early repayment on “private education loans.” See The League’s ii Release No. B069.
- The federal Servicemembers Civil Relief Act bars prepayment penalties on covered loans. See The League’s ii Release No. 0072.
- The ability-to-repay / qualified mortgage rule imposes certain limits on prepayment penalties. See The League’s ii Release No B074.
Consumer loans in Wisconsin
A credit union cannot prohibit a covered borrower from prepaying a loan or charge a prepayment penalty if the loan is subject to the Wisconsin Consumer Act. The League’s ii Release No. B001 explains which loans the Consumer Act covers. See Wis. Stats. §422.208.
The League’s consumer loan forms guaranty the right to prepay, saying that a “borrower may repay this loan, in whole or in part, at any time, without penalty for prepayment.”
Mortgage loans in Wisconsin
Two state statutes regulate prepayment penalties on certain mortgage loans.
Wis. Stats. Sec. 138.052
Section 138.052 of the Wisconsin Statutes applies to any loan (with some exceptions) secured by a first lien real estate mortgage on (or equivalent security interest in) a one- to four-family dwelling that the member uses as their principal residence. This broad definition may include purchase money loans, refinancings, home improvement loans, home equity loans, mobile homes attached to real estate, and HELOCs. (An “equivalent security interest” is a junior lien where the credit union holds the only senior lien.)
Under §138.052(2), a member may prepay a covered loan at any time in whole or in part. Prepayment penalties are generally limited in amount and often entirely prohibited. Prepayment penalties may only be imposed if provided for in the contract and then only during the first five years of the loan, notwithstanding any refinancing, renewal, extension, or modification of the loan. The penalty is limited to an amount not exceeding 60 days’ interest at the contract rate on the amount by which the aggregate principal prepayments for a 12-month period exceeds 20% of the original amount of the loan.
The League’s Real Estate Mortgage Note (WCUL #82042) includes a check box for use if the credit union wants the right to impose this prepayment penalty. Be sure to also indicate on the Truth in Lending disclosure that a prepayment penalty may be charged and disclose whether the loan will be subject to a rebate of any finance charge if prepaid.
See The League’s ii Release No. B047 for more information.
Wis. Stats. Sec. 138.056
Section 138.056 of the Wisconsin Statutes applies to the same first-lien loans covered by §138.052 (plus all first lien mobile home loans) if they are variable rate loans. A “variable rate loan” is a loan that permits the interest rate to be increased or decreased.
Section 138.056(3m)(a) says that lenders may not include a prepayment penalty in a variable rate loan using an approved index unless all the following are satisfied:
- The lender also makes variable rate loans without prepayment penalties and the lender provides the borrower with a written statement that the lender also makes variable rate loans without prepayment penalties.
- At the time of the offer of the variable rate loan, and the borrower acknowledges, in writing, receipt of the statement specified in item 1 above.
- The penalty is limited to prepayment that is made within 3 years of the date of the loan.
- The prepayment is not made in connection with the sale of a dwelling or manufactured home securing the loan.
See The League’s ii Release No. B030 for more information.
Business loans
Prepayment penalties can be common on commercial loans. We are not aware of state or federal regulations that would prohibit or limit state-chartered credit unions from including prepayment penalties in their loan agreements for business purpose credit that is not subject to consumer protection laws, like Wisconsin’s Consumer Act, or the other laws described in this Courier.
If your credit union has any doubts or concerns about its ability to impose a prepayment penalty on a business loan, consult with an attorney experienced in commercial lending.