How the Prepayment Penalty Works
Regardless of the day your FHA loan ends, you have to pay interest on the loan through the end of the month. This means if your refinance or sale closes on the 10th of the month, FHA keeps on charging you for the additional 20 to 21 days till month-end. This is considered to be a prepayment penalty.
Prepayment Penalties Have Been Hidden
Near the bottom of the Truth-in-Lending Disclosure, it says:
Prepayment: If you pay off early, you
may or will not have to pay a penalty
The lender checks the box next to may or will not. Most lenders check the box for will not, thinking that the FHA prepayment penalty is not like the sub-prime prepayment penalties. But the FHA does have a prepayment penalty, and the may box should be checked accordingly.
Thus, most home owners with a FHA loan have had their prepayment penalty hidden from them.
FHA Will Discontinue Prepayment Penalties
The good news is that for loans that close on January 21, 2015 or later, there will be no prepayment penalty, regardless of when you refinance or close on your sold property.
For everyone who already has an FHA loan, you’ll want to time the closing of your next loan to be on the last day of the month to avoid paying extra interest.
If you used an FHA loan (3.5% down payment) when you bought your house, get out the Truth-in-Lending form. Near the bottom, you’ll find in bold Prepayment Penalty. Is the box checked for may have or for will not have a prepayment penalty? Regardless of which box is checked, if you close your loan on any day of the month except for the last day, you will pay a penalty.
Question: “Can they do that? My documents says I will not have a prepayment penalty!”
Answer: Yes they can, and I guarantee you that they will. If you pay off your mortgage in the middle of the month, FHA will charge you interest for the entire month, no matter when you vacate the loan. So essentially, you are paying FHA extra interest payments even after the loan is closed. This is a prepayment penalty.
How They Keep It Hidden
When they calculate the pay-off balance on an FHA loan, they roll in those extra days of interest on what you owe. If you wonder why your pay-off figure seems too high, the FHA prepayment penalty could explain it.
How to Avoid the Prepayment Penalty
If you have an FHA loan, you need to close on the last day of the month. If that is not possible, close as near to the last day as you can in order to minimize your financial penalty.
FHA is Making Millions on Hidden Prepayment Penalties
In just one year alone (2003), FHA pocketed an extra $587,400,000 in profit from home sellers’ prepayment penalties. Over the course of the last decade, that multiplies to billions of dollars charged to unsuspecting first time home sellers and home owners refinancing.
Stop the Madness!
In 2011, U.S. Senator Ben Cardin (MD-D) tried to pass a bill stopping FHA’s prepayment penalty. Unfortunately, FHA poo-pooed the bill and it failed to pass.
Now the Consumer Financial Protection Bureau (CFPB) is pressuring FHA to stop the penalty. They say it’s not fair, and they want FHA to knock it off.
FHA is Fighting Back
FHA says if they are forced to drop the penalty, then new borrowers “can expect to pay a slightly higher rate.”
Thanks a lot FHA. Now you’re going to charge ALL home buyers at the beginning of the process instead of only the ones who don’t close at the end of the month?
New Policy Won’t Affect Existing Home Owners
If the new policy passes — and I think it will — it won’t affect current home owners. The existing loans will still be subject to the financial penalty. So be vigilant about your closing date. Make sure you close at the end of the month to avoid the paying extra.
Can 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.