So a little follow-up, and note of caution to add to my earlier bash of big banks. One of the more nefarious actions banks have taken over the last few years is to insert “brake funding” clauses into their loan agreements. If you are currently negotiating a loan I would be very careful to make sure your lender doesn’t sneak in this clause, as it is a disaster when you try to refinance. And before you attempt to refinance an existing loan, check carefully, as banks tend to hide these nasty little paragraphs.
Brake funding, which is also known by a variety of other names, essentially creates a large penalty if you attempt to refinance or pay off your loan early. The bank essentially hedges their profit. So a loan might have a traditional pre-payment penalty, which is usually easy to understand, and a brake funding clause, which even a Nobel Laureate in Applied Mathmatics could not compute.
The bank develops a calculation that takes into account their cost of funds, and essentially their loss of profit if you were to pay off the loan early. The problem is that the consumer cannot calculate the amount. The wizards in the bank’s back office have to tell you what the fee would be, as only they know what their cost of funds is. And in this age of “big banks / no service” just getting the bank to tell you what you owe them can take weeks. But the results can be stunning – with fees that total almost ten percent of your total loan.
One of the biggest problems with the clauses is that even your banker does not understand them. The bank sneaks them into the agreement, the banker doesn’t point them out or explain them, and the consumer is left to pay the price. I recently discussed them with two bankers, and both said the same thing – “I hate them. I don’t understand them. And they make my clients really really angry.”
I encountered clauses with both US Bank and Key Bank, so I suspect they are common. The private bank I work with told me they considered them unethical and would not use them. My advice, if you are shopping for a loan and have even the slightest anticipation you might refinance or pay it off early, do not sign an agreement with this kind of clause.