Consumer protection regulators press the FHA to revise a policy of collecting a full month’s worth of interest even when borrowers pay off their loans earlier in the month.
|Among major players in the mortgage field, the FHA is the only one that requires full-month interest payoffs. Above, a sign is posted outside a home in Indianapolis. (Michael Conroy, AP / April 9, 2013)|
WASHINGTON — Pressured by consumer protection regulators, the Federal Housing Administration is expected to end one of its most controversial practices: charging borrowers interest on their home mortgages for weeks after they’ve paid off the entire principal balance.
FHA officials declined to discuss the agency’s long-standing policy of collecting a full month’s worth of interest — hundreds of dollars extra in many cases — even when borrowers terminate their loans earlier. For instance, if you pay off your FHA loan July 3 to buy a new house with a conventional mortgage, the FHA will demand interest charges on your mortgage through July 31, collecting it out of the settlement proceeds.
But under the Consumer Financial Protection Bureau‘s “qualified mortgage” rules, charging interest after a principal balance payoff “is the functional equivalent of a prepayment penalty,” according to the bureau. The Dodd-Frank Wall Street Reform and Consumer Protection Act, which created the bureau, prohibits prepayment penalties on qualified mortgages — that is, residential loans that incorporate key consumer safeguards and are underwritten to limit risks for lenders and borrowers alike.
Qualified mortgages are expected to become the gold standard for home loans in the coming years and will offer the lowest rates and best terms available in the marketplace. The Dodd-Frank law designates the consumer bureau as the federal government’s drafter of rules spelling out what constitutes a qualified mortgage.
Among major players in the mortgage field, the FHA is the only one that requires full-month interest payoffs. Fannie Mae, Freddie Mac and the Department of Veterans Affairs all stop collecting interest on the day of payoff.
For more than a decade, the FHA’s practice has drawn congressional and real estate trade group criticism, most recently from Sen. Benjamin L. Cardin (D-Md.), who sponsored legislation during the last Congress that would have banned it. The National Assn. of Realtors also has been a vocal critic and has launched multiple efforts in recent years to persuade the agency to abandon its policy, all to no avail.
The realty group estimated that during one year alone — 2003 — the FHA collected $587 million in “excess interest fees.” With today’s lower interest rates, the sums involved probably would be lower, although the FHA’s loan portfolio and market share have increased.
Cardin, who typically is a strong supporter of the housing agency, complained in a statement introducing his legislation that “this is an issue of fairness. Homeowners should not have to pay interest on loans that they have fully repaid.”
The FHA’s policy, which is tied to a guarantee of a full month’s interest payments to investors in so-called Ginnie Mae mortgage-backed bonds, has had the side effect of encouraging many borrowers to seek to pay off their loans as close as possible to the final days in the month to avoid the hefty interest penalties.
However, when mortgage lenders, title companies and settlement firms are busy — as they have been lately — it’s often not possible to schedule an end-of-the-month settlement, causing some refinancers and sellers to pay more at the closing than they expected. Those extra payouts can be shocks to unwary sellers and refinancers who have modest incomes and resources, as many FHA borrowers do.
In its final qualified mortgage regulation, which goes into effect next January, the consumer bureau said it had “consulted extensively” with the FHA about its interest-charging practices and had agreed to allow the housing agency additional time — as much as a year extra — to implement the necessary changes.
The FHA is drafting a formal regulatory proposal aimed at bringing the agency into full compliance. At the end of that process, the FHA presumably will collect interest only through the date of payoff of a mortgage, rather than the full month.
That should be welcome news to critics, who say the FHA’s recent series of increases in monthly mortgage insurance premiums and its June 3 revocation of new borrowers’ rights to cancel premiums at any time during their loan terms are driving moderate-income borrowers away from the agency and making home-buying less affordable.
The take-away here: Until the FHA changes its policy, try to schedule any early mortgage payoff or closing on a refinancing as late in the month as possible to avoid punitive interest charges.