Could the federal government's booming FHA mortgage program be forcing homeowners to pay tens of millions of dollars of extra interest charges when they sell their houses or refinance their loans?
Critics say yes. The government says the critics aren't providing the full picture.
Those critics include Sen. Benjamin L. Cardin (D-Md.), who is sponsoring legislation that would prohibit Federal Housing Administration lenders from collecting a full month's worth of interest from sellers and refinancers who pay off their mortgages — close escrow — before the final day of the month.
No other major source of financing — not Fannie Mae, Freddie Mac or even the VA — requires interest payments from borrowers beyond the date they pay off their loans. On an FHA loan, however, if you sell your house and close early in the month, you are charged interest through the rest of the month.
To illustrate: Say you pay off a $200,000 FHA-insured mortgage April 5. You'll be charged an extra $820 to cover interest for the remaining days of the month, according to estimates prepared by the National Assn. of Realtors, which supports Cardin's bill. If you pay off the same loan April 15, the additional interest would total $492.
Where does the money go? Ted Tozer, president of the Government National Mortgage Assn. (Ginnie Mae), which bundles FHA loans into bonds and sells them to investors, said it flows to the bondholders, who are guaranteed payment of interest for the full month even if the balance is paid off much earlier.
Tozer said the approach afforded FHA borrowers a slight discount on their initial interest rates — probably in the range of 0.10% to 0.15% — compared with conventional loans.
But critics charge that the extra interest payment has a far greater economic effect on FHA sellers and refinancers — often cutting their proceeds by hundreds of dollars — than the barely perceptible rate break they received on the mortgage itself.
"This is an issue of fairness," Cardin said. "Homeowners should not have to pay interest on loans that they have fully repaid."
His bill, the Reduce Excessive Payments Act, would prohibit the practice and require FHA lenders to compute payoffs on a per-diem basis rather than a full-month basis.
Real estate agents are especially critical of FHA's interest prepayment policy because they say it squeezes money out of sellers who have little or no control over the timing of their closing. Many sellers don't know about the FHA's requirement, realty agents say. Even if they do, the buyers of their houses generally are in a better position to control the closing date because they are dealing directly with title and escrow companies.
The National Assn. of Realtors says the out-of-pocket costs to unwary consumers are huge. Citing the most recent statistics on early payoffs that it claims it could obtain from the FHA, the group says that during 2003:
•FHA borrowers paid $587.4 million in "excess interest fees" because of the full-month rule.
•Only 16% of loans were prepaid during the final five days of the month.
•The average "excess interest" payment from borrowers to lenders and investors was $528.
Between January 2000 and January 2004, according to the Realtors' analysis of FHA data, borrowers paid more than $1.375 billion in excessive interest. The corresponding amounts today could be significantly higher since the FHA has a much larger market share.
Asked for comment, Vicki Bott, who heads the FHA's single-family mortgage office, acknowledged the controversy and said the agency was "examining this issue very closely" and considering a regulatory change.
Tozer said Ginnie Mae could readily sell its FHA mortgage-backed bonds using the per-diem payoff approach that is standard in the conventional mortgage marketplace. But investors would still need to be compensated for the full month's worth of interest, he said, and that would probably require a slightly higher rate on the mortgage.
Where is this headed? With pressure coming from Congress, the FHA may move off its disputed practice.
In the meantime, if you have an FHA loan and plan to refinance or sell your house, try hard to schedule the close at the end of the month. You could save a bundle.
Distributed by Washington Post Writers Group.