Congress has taken up a bill which would change the manner in which the FHA charges interest on its loans after final payoff. S.488, more commonly referenced as the “Reduce Excessive Interest Payments Act,” was recently introduced in the Senate and forwarded to committee for review. The Act could greatly reduce the final charges imposed on FHA borrowers when they pay off their mortgages. It may also eliminate the stress faced by agents and sellers who feel compelled to time their closings for the end of the month.

FHA Interest Charges upon Payoff

FHA borrowers pay extra interest charges when they pay off their mortgage before the end of the calendar month. This is because the FHA uses a unique and somewhat unfair method for calculating final interest charges. For most mortgages, a borrower is charged for interest up through the date that the loan is completely paid off. The interest due is calculated based on a “per diem” rate which is determined according to the interest rate on the loan and the remaining balance. This is fair because the borrower is only paying interest for the exact amount of time that the loan is outstanding.

For example, if a borrower is current on his mortgage and he sells his home on the 2nd day of a 31 day month, that borrower’s final interest payoff will vary depending on whether the borrower has an FHA loan or a non-FHA loan. If the loan is non-FHA, the borrower will only be charged 2 days worth of interest for that last month – or a “per diem” interest charge. However, if the loan is FHA, the borrower will pay interest for the entire calendar month in which the loan is paid off. Essentially, the FHA borrower will be charged as if he held his outstanding debt for an additional 29 days.

This problem equates to hundreds and sometimes thousands of lost dollars for FHA borrowers. If a hypothetical loan balance upon sale is $200,000, and the interest rate is 5%, then the per diem interest fee to the borrower is $27.40. This means the non-FHA borrower in the above example would pay about $54.80 in interest upon final payoff, while the FHA borrower would pay closer to $849.40.

Close at the End of the Month

Experienced lenders and agents are usually aware of this unique FHA inequity and advise clients with an FHA loan to try and close their sale at the end of the calendar month. However, extensions, delays and other normalcy’s of the everyday real estate transaction often make it difficult to successfully time a closing. As such, many in the housing industry have looked to Congress to change things.

The Act

The “Reduce Excessive Interest Payments Act” will require the FHA to charge interest on a strict per diem schedule. However, the Act will probably not change our industry or practices anytime soon because it is trapped in committee during an election year. Until Congress acts, agents and lenders should be aware of the FHA interest trap and be able to intelligently discuss the benefits of closing transactions at the end of the month with clients.