It’s an issue that bubbled up on Capitol Hill last week and pits Realtors against mortgage bankers: the Federal Housing Administration’s long-standing policy of forcing borrowers to pay a full month’s worth of interest at closing when they pay off their loans anytime before the end of the month.
An influential senator, Ben Cardin, D-Md., is sponsoring legislation that would require FHA to charge only per diem interest on prepayments of loans.
For instance, if an FHA mortgage were paid off on the sixth day of the month, whether in connection with a home sale or refinance, the borrower could only be asked to pay interest for those six days, rather than for the full remainder of the month, per the current rule.
Last week, Cardin offered his bill as an amendment to the Economic Development Revitalization Act of 2011, which was pending before the Senate.
That set off alarm bells at the Mortgage Bankers Association, which opposes any statutory change to the current practice, but drew strong support from the National Association of Realtors, which has advocated per diem collection of FHA payoffs for years.
Ultimately the floor debate on the big economic development bill was dominated by a controversy over ethanol subsidies, and Cardin’s amendment did not come up for a vote. But he says he intends to keep pressing for a change.
The Realtors see the issue as an anti-consumer money grab by bankers and Wall Street investors that home sellers encounter only with FHA and nowhere else in the mortgage marketplace.
Fannie Mae, Freddie Mac, the Department of Veterans Affairs and the U.S. Department of Agriculture’s Rural Housing program all use per diem interest as their standard.
In a June 13 letter to members of the Senate, NAR President Ron Phipps said that FHA borrowers are forced under this policy to pay millions of dollars a year in excess interest fees.
In 2003, the last time that NAR says FHA provided internal data to the trade group, "FHA borrowers paid more than $582 million in excess fees as a result of this onerous requirement in that year alone," said Phipps’s letter.
According to estimates prepared by NAR, home sellers paying off a $200,000 FHA loan on the fifth day of the month would be charged an extra $820 at closing for the remaining days in the month, even though they no longer live in the house and have completely extinguished their debt on the mortgage.
The Realtors say these extra charges reduce the seller’s proceeds unfairly — especially in situations where they have no control over when escrow or settlement agencies schedule the closing at the convenience of the new buyer or are jammed up with transactions at the end of the month.
Though many FHA borrowers do manage to get their settlements scheduled for the last day of the month or the first of a new month, some do not.
From the perspective of the Mortgage Bankers Association, the entire issue should be left up to FHA and its securitization partner, Ginnie Mae, to decide. In a letter to Senate leaders last week, David H. Stevens, the association’s CEO and the immediate past FHA commissioner, said, "FHA can make this change administratively" — if it chooses to do so — "and is currently conducting a cost-benefit analysis on the policy to determine if and how FHA should amend its policy."
The long-standing full-month interest practice itself, Stevens noted, "mirrors the Ginnie Mae mortgage-backed security, which provides that securities holders are entitled to a full month’s interest for the month of payoff."
Stevens added that although Cardin’s bill may be well-intended, "MBA believes it would actually increase costs for the vast majority of FHA borrowers. Lenders would be required to price approximately 15 days of interest into every mortgage transaction in order to offset the lender’s cost of passing through post-settlement interest to Ginnie Mae bond holders."
Ted Tozer, president of Ginnie Mae, said that that the full-month interest payoff approach — even though it may reduce home sellers’ proceeds — nonetheless has allowed the same borrowers to enjoy a small upfront discount on their mortgage interest rates when compared to conventional market interest rates. The discount, he said, is estimated to be somewhere in the range of 0.1 percent to 0.15 percent.
Cardin argues the rate break is not worth the out-of-pocket costs encountered by FHA home sellers and refinancers at closing.
Tozer, meanwhile, says that Ginnie Mae, which already uses the per diem interest approach in its VA and Rural Housing mortgage-backed securities , could handle a change to a similar approach by FHA if the agency so decided.
The outlook: FHA confirms that it is studying the issue. But at the moment, it has only an acting commissioner in the wake of Stevens’ departure and a long list of other rulemaking projects under way, so don’t expect a change overnight.