Can you be charged interest on your mortgage even after you’ve fully paid it off? Can the meter keep running when you owe the bank nothing – your principal balance is zero?
Surprise! Much to the chagrin of large numbers of home sellers and refinancers, the answer for years has been yes. If your loan was insured by the Federal Housing Administration and you paid it off before maturity, at closing you’d be expected to cough up a full month’s interest, no matter what day of the month you actually settled
Even if you closed on March 2, for instance, you would have been charged interest by your loan servicer through March 31, potentially adding hundreds of dollars to your costs in the transaction. FHA’s practice has been unique among major players in the housing finance marketplace. Fannie Mae, Freddie Mac and the Department of Veterans Affairs all require interest to be collected only to the day of principal payoff. After that, the meter stops.
But change is on the horizon. Thanks to a regulatory mandate from the Consumer Financial Protection Bureau, FHA has agreed to end its controversial full-month interest policy, but only for future borrowers. FHA has until next Jan. 21 to make the switch, so sellers and refinancers who currently have FHA-insured mortgages are cut out of the deal. Many will still get hit with extra interest charges.
Here’s a quick overview of what’s behind the agency’s belated retreat. For the past decade, homeowners and realty brokers have complained that FHA’s interest payment policy amounts to an unfair gouging. Not only were many sellers unaware of FHA’s odd requirement, but they didn’t factor the extra costs into their financial plans.
The National Association of Realtors, which began publicly criticizing the practice in 2004, said by insisting on full months of interest payments, FHA effectively has been squeezing tens of millions of dollars in unjustifiable extra charges out of sellers. In one year alone, 2003, according to the association, FHA borrowers paid an estimated $587.4 million in “excess interest fees.”
In 2011, complaints from constituents prompted Sen. Ben Cardin, D-Md., to introduce legislation that would have banned full-month interest charges and required FHA loan servicers to compute payoffs on a per-diem basis.
Cardin’s bill ultimately went nowhere. FHA brushed off its critics, arguing that by guaranteeing bond investors a full month’s interest on mortgages, its interest rates were slightly lower than its competitors’ rates. One mortgage industry estimate put the rate break at roughly 0.10 percent to 0.15 percent.