The Colorado Director of the Division of Real Estate has adopted an emergency rule regarding prepayment penalties effective December 14, 2007. The Director adopted the rule "in order to address the high rate of foreclosures in Colorado resulting from particular prepayment penalties." A copy of the emergency rule is available online here.

The emergency rule applies to adjustable rate mortgages, defined generally to include any loan with a teaser rate, payment rate or interest rate that changes periodically. After reminding mortgage brokers of their duty of good faith and fair dealing with a borrower, which duty includes recommending or inducing a borrower to enter into only those transactions that provide a "reasonable, tangible net benefit" to the borrower (see article on emergency rule on tangible net benefit in this issue), the Director puts the mortgage industry on notice that "transactions do not contain a reasonable, tangible net benefit if they contain a prepayment penalty that extends past the adjustment date of any teaser rate, payment rate or interest rate included in a mortgage loan." Indeed, the emergency rule creates a presumption that if a prepayment penalty extends beyond any of the aforementioned (or comparable) adjustment dates, then the mortgage broker has violated its duty of good faith and fair dealing and is subject to disciplinary action in the form of, among other things, license revocation or refusal to renew, fines and restitution.

Mortgage brokers operating in Colorado should carefully review their loan program guidelines as they apply to the imposition of prepayment penalties in connection with adjustable rate mortgages and conform them to requirements of the emergency rule.