Hundreds of thousands of home sellers have had their pockets picked at closings during the last decade: They've been charged interest on their mortgages after their principal debts had been fully paid off.
This practice, endorsed by a federal agency, cost consumers staggering amounts, with estimates ranging into the hundreds of millions of dollars a year during periods when mortgage rates were high.
But thanks to a policy switch that was recently made final, charging extra interest payments on loans insured by the Federal Housing Administration will soon be banned.
The FHA, which traditionally has served as a major source of financing for moderate-income first-time buyers, many of them African American and Latino, for years has allowed lenders to charge borrowers a full month of interest when they sell or refinance a home. This has been the case even when borrowers pay off the mortgage weeks in advance of the end of the month.
Picture this. Say you went to closing on an FHA loan Sept. 3. Under standard industry rules followed by Fannie Mae, Freddie Mac and the Department of Veterans Affairs, your interest charges cannot extend beyond that date. But under the FHA's long-standing policy, lenders have been allowed to hit you with interest charges through Sept. 30.
Why? Good question. The Consumer Financial Protection Bureau essentially posed it to the FHA last year: Aren't you allowing lenders to soak hapless consumers with post-payment penalties at closings when they have no alternative but to pay up? And, more to the point, didn't the Dodd-Frank financial reform legislation of 2010 prohibit penalties of this sort? How is your policy, which sometimes results in unexpected extra charges of hundreds of dollars, legal?
The FHA argued that the bond investors who buy packages of insured mortgages expect full-month payments of interest plus principal, and that in any event, FHA lenders charge borrowers slightly below market rates to help compensate for the post-closing payments. But critics said there was no way this alleged bargain favored borrowers, who inevitably paid far more in extended interest than they ever received in hair-splitting "reduced" interest rates.
The National Assn. of Realtors, which had railed against the FHA's policy for more than a decade, estimated that during 2003 alone, sellers and refinancers were forced to pay nearly $690 million in extra interest charges. Realtors in Maryland even persuaded Sen. Benjamin L. Cardin (D-Md.) to introduce legislation that would have prohibited the extra interest fees. But the FHA didn't like the bill, and it died without getting even a hearing in the Senate.
Asked for comment on the FHA's policy change, Realtors association President Steve Brown said he applauded the move, which was "long overdue" and should "result in cost savings for millions of Americans who rely on FHA-insured loans to purchase their homes."
Here are the details of the policy reform: Starting Jan. 21, new FHA mortgages will require lenders to collect interest only on the balance remaining on the date of closing for a home sale or refinancing. Under the revised policy, if you're selling your home and you have a $150,000 balance left on your FHA loan, the lender will have to stop charging you interest on the date of the closing, not compute the interest charges that would be due through the end of the month and roll them into your bottom line.
In guidance published in the Federal Register, the FHA urged lenders not to find new ways to penalize borrowers. The agency said they should "look elsewhere" to recoup whatever revenue they expect to lose by virtue of the policy change, and continue "to offer consumers the same interest rates that they offer now" rather than finding some way to tack on a premium.
So could these changes make the FHA more attractive to borrowers compared with the alternatives? Yes, but there are two caveats: Sellers and refinancers who currently have FHA loans and expect to close before Jan. 21 probably won't see much benefit. Plus the FHA's other current negatives — super-high mortgage insurance premiums that can't be canceled for extended periods — won't be disappearing.
Nonetheless, the FHA remains the go-to choice if you have minimal down payment cash (3.5%), issues in your credit files and you are not eligible for a VA loan, which is the best deal around with zero down and generous underwriting.