Should You Eat Your Prepay?

Consider this scenario. Two years ago you, a self-employed California home owner with good credit, were talked into taking a neg-am adjustable rate mortgage for "the payment flexibility" by a slick-talking loan officer.  In order to get a "no points, no fee" loan you took a 3-year hard prepayment penalty with the loan.  That prepayment penalty isn't up until some time late next year. Your home is "worth" $550,000 right now, down from $600,000 a few short months ago, but there are homes on the market that have been sitting and you feel future price devaluations are imminent.  You bought before the peak of the market and have 25% equity currently at $550,000. You have no problem making the fully-amortized payment; but your Option ARM loan (scheduled to recast in 3 years) has a