The following article is reprinted from Basis Points® , Vol. 1, Issue 4, Copyright © 2002, with the permission of CounselorLibrary.com, LLC. All Rights Reserved. Further reproduction is prohibited without permission.

One of the most widely used prepayment penalty provisions has been declared unlawful in Massachusetts. Under the penalty provision, the borrower is permitted to prepay up to 20% of the principal in any 12-month period. However, amounts prepaid in excess of 20% will be assessed a penalty (typically, six months' interest.) Well, according to the Massachusetts Division of Banks, you better not bring that game to Massachusetts.

The Massachusetts Division of Banks reviewed the language of Massachusetts General Laws chapter 183, section 56 relative to mortgage loans in the Commonwealth. Section 56 limits prepayment penalties on mortgage loans secured by a first lien on a one-to three- family home occupied in whole or in part by the mortgagor. Under the Massachusetts statute, a lender may collect the balance of the first year's interest or three months' interest, whichever is less if the loan is prepaid within the first year. If the loan is prepaid within 36 months from the date of the note for the purpose of refinancing with another institution, an additional payment not in excess of three months' interest may be required.

However, the Division of Banks found that there is no language in section 56 that authorizes a prepayment penalty for a partial prepayment of a mortgage note. Therefore, the Division took the position that the language presently included in the promissory note, which assesses a penalty for a partial payment of a mortgage, is not in compliance with said chapter 183, section 56. Furthermore, the prepayment provision, as written does not comply with section 56 and should be revised accordingly.

Does anyone really care? I mean, isn't it generally assumed that a mortgage banker can rely on the Alternative Mortgage Transactions Parity Act (AMTPA) to preempt state limitations on prepayment penalties? Well, you need to keep two things in mind. The first is that not all mortgages are "alternative" mortgages. If you have a fixed rate loan, with fully amortizing payments, you probably do not have an "alternative" loan that will trigger the preemption. Second, the preemption does not work in all states. Some states, like Massachusetts, opted out of the federal preemption. That means that AMTPA does not apply in Massachusetts. Arizona, Maine, Massachusetts, New York, South Carolina, and Wisconsin have, in some fashion, opted out of the Parity Act.

Arizona opted out of the federal preemption only as to balloon-payment loans. In Arizona, balloon payments are prohibited on a loan in an amount of $10,000 or less for a term up to three years that is secured by a junior lien on an owner-occupied dwelling. However, this prohibition does not apply to transactions involving the purchase or sale of real property or to a financial institution licensed or chartered by the state of Arizona or the federal government.

Wisconsin opted out of the Parity Act, but the override of federal law applies only to consumer credit transactions made under the Wisconsin Consumer Act.

Maine, Massachusetts, New York, and South Carolina have elected to opt out of the provisions of the Parity Act as to all alternative mortgage transactions.

For more information, see the June 21, 2001 opinion (01-073) from the Massachusetts Division of Banks. (http://www.state.ma.us/dob/01-073.htm)

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