Sneaky Prepay Penalty Snares First Time Home Buyers

money walletCan you imagine?! You pay off your mortgage (either by refinancing or selling the property), and even though you have a $0 balance, the lender keeps on charging you interest every day for the rest of the month.

“Can they do that?” you ask.

Yes, FHA (Federal Housing Admin) is and has been doing that to all their first time buyers who used their 3.5% down FHA loan.

This sneaky practice netted FHA an extra $587,000,000 in revenue–in one year alone, according to an article in the Washington Post by Kenneth R. Harney. Over the years, it’s added billions to their coffers.

What this amounts to is a prepayment penalty. If a home owner pays off their balance before the end of the month, they are penalized for the “early payment” and still have to pay their entire month’s payment. However, this is not disclosed to people up front. In fact, most of the time it is a BOLDFACE LIE. On the Truth-in-Lending form (TIL) near the bottom where there is a box to check yes or no for a prepayment penalty, the majority of banks and lenders check no prepayment penalty.

By contrast, conventional loans and VA loans stop charging their borrowers on the day the loan is paid off.

The National Association of Realtors has been complaining about FHA’s prepay penalty for years — to no avail. But now the Consumer Financial Protection Bureau has added its muscle to the fight, and it looks like the FHA might be forced to stop grabbing extra dollars out of their customers’ wallets. However, the CFPB has given FHA a year to comply with their request, so we’ll have to wait to see how it all plays out.

In the meantime, if you are paying off an FHA loan, plan your closing for the end of the month so you don’t pay any (or many) extra days of interest payments.

5 responses

  1. We sold our home & closed today (7/23/13), but Bank of America is charging me interest through 8/31/13. How can they do this??

    1. Laura, did you have an FHA loan? If so, you can see by reading my blog post that that is the way FHA works. Your loan officer should have told you to wait to close until the end of the month. All GOOD loan officers watch out for clients who have an underlying FHA loan so they don’t get charged for days they no longer have the loan. However, if your interest rate lock was expiring 7/23, then that would trump the FHA prepayment penalty. I think you should speak with your loan officer about this, and I would be interested in hearing what he/she says.

      1. I spoke with BOA today and was assured that as soon as the payoff processes, I will be refunded the interest that is beyond. She said they should receive the payment by Thursday and process it by Friday, thereby eliminating the interest from 7/27/13 to 8/31/13. I’m to call back on Friday to find out how much they are refunding.

      2. Thank you for letting me know the good ending to this scenario. That is GREAT news!

  2. Sorry- yes it is an FHA loan.

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