ATLANTA -- Interest rates are inching up, and many consumers may want to pay off mortgages or their home equity lines early to avoid the higher costs.

But a hidden penalty in many borrowers' contracts could penalize them for trying to pay the debt sooner.

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Meet Roger Behrstock

Roger Behrstock considers himself a smart businessman so he was shocked when he tried to refinance his adjustable rate mortgage in order to obtain some extra cash.

"I was surprised to find out that I had a very large prepayment penalty on my existing loan," he said.

Behrstock was hit with an $8,743.99 prepayment penalty because he paid off the original loan within the first few years and ahead of time.

Prepayment penalties used to be common only on high-risk loans, but experts now say that they are growing more common.

"In the last three or four years, we've seen a dramatic increase," said mortgage broker David Soleymani.

Research shows that prepayment penalties are included in 50-60 percent of adjustable rate loans. Also, 60 percent of home equity lines of credit carry early termination fees.

"It's clearly, I think, a sign of what's to come in the future," said Soleymani.

The fees can add up quickly.

"For some home equity lines of credit it might be $150 or $300," said Holden Lewis, a spokesman for Bankrate.com. "For some types of mortgages you could end up paying six months of interest."

Banking industry officials say the penalties are frequently used in lending to offset costs.

Soleymani said borrowers are offered incentives to take the penalty.

"They'll typically derive a discount, either in the interest rate or in the points that they're paying," he said.

But Lewis said many borrowers fail to learn about the penalty when they first take out the loan.

"A lot of consumers don't read the small print," he said.

Industry officials say it is critical that borrowers do their homework before meeting with finance officials. Also, borrowers should be sure to ask if there is a prepayment penalty.

If there is, officials say consumers should find out the exact details about the penalty, including how long the prepayment penalty will last and whether the borrower gets anything in return.

Consumers should ask themselves "am I getting a lower rate (or is the lender) paying the closing costs," Lewis said.

Behrstock said he wishes he had asked those detailed questions before agreeing to the loan. He agreed to complete the refinancing despite the prepayment penalty. However, he said he will never be caught off guard again.

"In the future, I'll check my existing documents," he said. "I should have been more aware."

Clark Howard's Advice

Consumers who are shopping for a home should not consider an adjustable rate loan because of rising interest rates. Prepayment penalties will also take a bite out of a borrower's wallet, with most of the proceeds going to the bank.
Would-be borrowers thinking about taking out a home loan should get a fixed mortgage. A 15- or 30-year fixed-rate loan is currently the best thing on the market. In many cases, borrowers can pay off up to 20 percent of a loan without triggering the prepayment penalty.
Borrowers should be careful about prepayment fees on other types of loans, including ones for cars.