A California deed of trust on an owner-occupied single-family residence contains a prepayment penalty clause imposing a charge if the borrower pays off the loan within the first three years. Under California Civil Code 2954.9, how is this clause treated?
Correct Answer
A) Enforceable for the three years, but the charge is capped at six months' interest on the amount prepaid above 20 percent of the original principal in any 12-month period
Civil Code 2954.9 governs prepayment of loans secured by residential property of four units or fewer. For owner-occupied property in that class, a prepayment charge may be imposed only on a prepayment made within five years of the date the mortgage or deed of trust was executed. Inside that window the borrower may still prepay up to 20 percent of the original principal in any 12-month period without charge, and any charge on the excess may not exceed six months' advance interest on that excess. A three-year clause therefore sits inside the five-year window and is enforceable, but only as limited by the 20 percent allowance and the six-month interest ceiling.
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