Some are charged interest on paid-off loans

Nation's Housing

April 11, 2004|By KENNETH HARNEY

WHEN YOU PAY off your mortgage, the interest charges stop immediately, correct?

Most of the time, the answer is yes. But for thousands of homeowners every year, the meter just keeps running. They are charged days or weeks of interest beyond the legal life of their mortgages.

If they refinance or close on a new house on the 10th day of the month, they are charged interest on their mortgage through the final day of the month - 20 or 21 days later. If they pay off the loan on the 20th, they owe another 10 or 11 days in interest. That, in turn, can add hundreds of dollars in additional costs at closing.

Who are these unfortunate folks, and why have their extra interest outlays become a matter of controversy on Capitol Hill?

They are homeowners who refinance or pay off their FHA (Federal Housing Administration) loans. For more than three decades, FHA loan documents have carried standard language alerting borrowers that if they pay off their notes after the first day of any month, they will be charged interest for the remainder of that month.

The reason is that FHA-insured mortgages are virtually all financed by capital market investors, who purchase mortgage-backed bonds guaranteed by Ginnie Mae, the Government National Mortgage Association.

The bonds guarantee the investors interest payments from the underlying mortgages through the end of each month of their existence. The investors pay for that guarantee when they buy the bonds.

Many FHA borrowers, realty agents and mortgage brokers apparently are aware of the full-month interest payment rule, because FHA loans are often paid off in the final week of the month. Estimates by the Mortgage Bankers Association of America suggest that 70 percent of all FHA loans are paid off within that time frame or on the first of the month.

However, the National Association of Realtors disputes that statistic, arguing that more than 40 percent of FHA borrowers close during the first 10 days of the month - exposing them to at least 20 days of interest payments after the termination of the mortgage. The Realtors estimate that, during 2003, 55 percent of all FHA customers who terminated their loans paid an average of $528 in "excess interest fees," a cumulative "prepayment penalty" to those borrowers of $587 million.

John W. Anderson, past chairman of the Realtors' federal housing policy committee, said the clear loser in the full-month interest policy is "the one who can least afford it, the consumer." The million-member realty association is pressing Ginnie Mae to change its long-standing prepayment policy. Failing that, it wants Congress to step in and prohibit Ginnie Mae from collecting interest beyond the day of closing.

Michael Frenz, Ginnie Mae's vice president for capital markets, said the issue is more complicated than it sounds. All mortgage bond investors - be they purchasers of Ginnie Mae, Fannie Mae or Freddie Mac securities - expect and receive interest payments through the full month. Ginnie Mae's policy for years, according to Frenz, has been to "encourage borrowers to pay off either on the first day of the month or late in the month" to minimize extra interest payments.

If Ginnie Mae forced mortgage servicers - the lenders who administer the loan accounts on behalf of the bond investors - to pay the extra interest, "they would have to recover" that money in some way, and would raise interest rates on all FHA loans, Frenz said. That would increase costs for all first-time homebuyers and others using FHA mortgages.

The Mortgage Bankers Association of America, which represents FHA mortgage lenders and servicers, agrees. In a recent letter to Ginnie Mae, the association estimated that home lenders would be forced to raise rates on all FHA borrowers by as much as one-quarter of 1 percent if they - not borrowers - were stuck with the extra interest payments due bond investors.

The realty association disagrees. Free market competition among lenders will minimize any extra interest or fees charged to FHA borrowers, Anderson said.

Where does all this leave new homebuyers and the 7 million borrowers who already have FHA mortgages? Probably scratching their heads. Until Congress decides to change the rules, here's how consumers can handle the issue: First, be aware of the FHA "prepayment penalty." If you work with your realty agent, lender and settlement agents, you should be able to schedule your FHA loan payoff late in the month or on the first day of the month.

If one or more of those service providers knocks your settlement date off that timing track - and you did not personally contribute to the problem - ask the guilty party to pony up the extra interest you're being asked to pay.

Ken Harney's e-mail address is kharney@winstarmail.com.

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