As mentioned in an earlier item, the prepayment penalties associated with 232(a)(7) HUD loans could be financially beneficial because of substantial monthly savings, even on loans that are only a couple of years old with large 8% or 9% prepayment penalties. Many HUD lenders will pay these penalties for you, but the cost of these prepayment payments is wrapped into your loan in the form of a higher interest rate (I have seen estimates of 75 to 125 basis points). I caution borrowers to compare the interest rates available with the prepayment paid by the lender against the rate that would be charged if the borrower paid the prepayment penalty directly. Borrowers may find it worthwhile to beg, borrow or steal the funds required for this prepayment penalty. Also, check with your accountant to see if the prepayment penalty paid by the borrower is a tax deductible expense. If so, this is an additional immediate additional benefit.

UPDATE MAY 25, 2012:

Due in large part to the flight from European bonds, the rates being charged by lenders to cover HUD prepayment penalties have decreased drastically to between 50 bp and 100 bp. This change from even a few weeks ago has now made it worthwhile for borrowers to seriously consider taking the funds from the lender and adding onto the interest rate. As an aside, we are seeing rate locks on HUD loans at 2.75% (without the prepayment penalty bump). All of this is subject to change on a daily basis, but for now, borrowers have to carefully evaluate the different financing options available to them with respect to the HUD prepayment penalties.