Tracy Stefan sees a lot of people who end up paying more than they expect when they're closing on a mortgage, and those who can't be warned in time to prevent it aren't happy.
Unlike some closing costs, one particular pitfall often can be avoided -- or at least minimized -- with a little planning.
Stefan is a loan closer at Burnet Title, and like many of the people she works with, she has a home bought with a loan guaranteed by the Federal Housing Administration.
One of the terms of FHA loans is that when they're paid off, interest must be paid through the end of the month. So someone selling a house with an FHA loan and buying another house should try to schedule closing for the last few days of the month. Closing on March 15, for example, would mean paying interest on the old loan through the 31st -- while also paying interest on the new loan.
It's a situation that the National Association of Realtors (NAR) considers unfair, and that it tried -- unsuccessfully -- to change last year.
"I see it all the time," Stefan said. "We try to let people know as soon as we realize there's an FHA payoff. We have to jam all the [FHA] closings in at the end of the month so we get their payoffs to the lender by the first of the next month, so they don't have to pay interest for the rest of that month."
However, that's not always possible. Last-minute problems can delay closing past the time a payoff check can reach the lender by a typical 10 a.m. or noon deadline on the first of the month. When that happens, "the sellers have to pay another month's interest in order to sell their home," Stefan said. "It's not fun to be the one to tell them. ... A lot of times they need, or were expecting to have, every penny for their next house. And if it's another $300 or $400, it's a lot of money to them."
Stefan said Burnet Title tries to warn FHA sellers so they can set the right closing date. And she has refinanced her home in St. Paul twice, each time avoiding extra interest -- although when business is booming, she has so many closings that it's hard to schedule time for her own.
John Anderson, manager of Twin Oaks Realty in Crystal, said Realtors and people he knows in the mortgage industry say the FHA payoff issue comes up constantly, and it has been a common topic during all his 23 years in the business. Last year he got his best chance to do something about it when he was chairman of the NAR Federal Housing Policy Committee and made efforts to repeal the rule its top priority.His committee got audiences with the appropriate officials, but no relief.
"The economic gainer or loser in this situation is the one who least can afford it, the consumer," Anderson wrote in a Jan. 30 letter to Ronald Rosenfeld, president of the Government National Mortgage Association. Ginnie Mae, as the organization is known, is a government-owned corporation within the U.S. Department of Housing and Urban Development (HUD) that insures FHA and VA mortgage loans.
Anderson noted that Realtors won't benefit from repealing the rule. He called it an issue of "simple fairness."
The whole-month interest requirement is stated in the documents for closing an FHA loan, but many consumers don't see it, don't pay much attention or simply forget, he said.
The requirement
The requirement is simple: FHA mortgage payments are due on the first of the month, and borrowers who pay off their loans after that must pay the full month's interest. This doesn't usually mean cash out of pocket, Anderson said. The money generally is subtracted from the net amount going to the seller.
Refinancing is even more complicated, because Minnesota law requires a three-day rescission period. Funds aren't distributed until that period is up, so "if you close on Monday, they don't disburse until Friday," Stefan said.
Anderson thinks the majority of FHA homebuyers don't understand that when they sell or refinance, they might have to pay such interest. "Most people say, 'I didn't think there was such a thing as a prepayment penalty.' It's not really a prepayment penalty, but it is a penalty. Most of the time they don't realize it until they see their payoff statement. ... Even if they are buying their second house, these typically are people who don't have a lot of extra money, so an extra $500 to $700 ... is very important to them."
Even sellers aware of the requirement can get clobbered by it through no fault of their own if a closing is delayed, and when that happens, sellers usually are the most upset, he said. For example, a closing scheduled for the 28th of the month might get delayed because of late paperwork, failure to transfer funds on time or a crush of closing business.
"Say it goes from the 28th of the month to the third of the next month; and now the seller has to pay another whole month of interest," he said. "You'll be paying interest for the rest of the month on your old house, plus you're paying interest on the new house. ... That's money taken out of the consumer's hands that could have been used for something else."
Seeking a fix
Anderson, long active in NAR affairs and past president of both the Minnesota and Minneapolis-area associations of Realtors, said NAR has been working to undo this requirement for more than five years. Last summer he met with John Weicher, HUD assistant secretary for housing. "He said to me that as far HUD was concerned, it was willing to make this change but Ginnie Mae was the organization that would have to change its rules."
Anderson said that Rosenfeld, Ginnie Mae president, appeared very interested and said that ending the rule seems to make sense for consumers. But he wanted data, not just anecdotes about the effects on consumers. So HUD produced data for NAR showing that in 2003:
• 55 percent of FHA borrowers who paid off loans before the end of their terms did so before the 15th of the month, and they paid an average of $528 in what Anderson called "excess" interest.
• More than 425,301 borrowers, or 26 percent of all FHA borrowers, paid before the fifth of the month and paid an average of $622 in excess interest.
• In each of the past three years, about 25 percent of FHA loans were prepaid in the first five days of the month.
• Last year, only 16.4 percent of FHA loans were paid off in the last five days of the month. For the three years before 2003, that number was between 18.4 and 18.7 percent.
• Last year, borrowers paid a total of $587,425,543 in excess interest.
• Since January 2000, FHA borrowers paid more than $1.375 billion in excess interest.
Lenders support status quo
Anderson said Rosenfeld told him that the mortgage-lending industry thought ending the rule would be bad for consumers -- that investors who buy the loans count on that extra interest money and ending it would cause an increase in FHA interest rates. That's also the position of the Mortgage Bankers of America (MBA).
Anderson disagrees, pointing out that VA and conventional loans charge interest only until the payoff date and that a brief analysis of prevailing rates shows that VA loans don't have higher interest rates than FHA loans. NAR's position is that market forces would prevent higher rates; if some lenders withdrew from FHA financing, others would seize the opportunity to make those loans.
"I find that farfetched," said Steve O'Connor, MBA vice president of government affairs. "That's a lot of product for investors to absorb. Ginnie Mae has been the security of choice for FHA loans." At Ginnie Mae's request, MBA did its own study, which found that "in the aggregate it was going to raise costs for more FHA borrowers than it was going to help," O'Connor said.
"Currently, only a minority of FHA borrowers are affected adversely," he said. "To make the change that was suggested [by the Realtors] ultimately would result in all borrowers having to pay increased costs. MBA thinks the better solution is to help educate consumers as to why they close their loans at the end of the month or the first day of the month. ... Ideally, you schedule the closing [for] the end of the month."
Anderson responded that closing dates frequently are out of consumers' hands. One closing often is part of a chain of events linked to other closings, and other parties involved in the transactions might object to closing at month's end.
In addition, title firms can hold only so many closings at month's end, and they aren't likely to reserve days, he said.
What's next?
Anderson has been drumming up interest in the issue in Washington, D.C., for more than a year. Rep. Robert Ney, R-Ohio, wrote to Rosenfeld on March 18 asking that Ginnie Mae submit its recent informal review of the policy and the rationale for it to the House Committee on Financial Services, on which he serves. He wrote that members of Congress and the committee have expressed interest in modifying the prepayment policy over the years.
Absent an explanation, he wrote, "it appears that the prepayment policy adversely affects our American consumers and indirectly affects the availability of affordable housing." He noted that "FHA-insured borrowers usually are first-time, minority, rural or inner-city home buyers."
Steven Nesmith, HUD assistant secretary for congressional and intergovernmental affairs, replied April 1 that the policy dates to 1970. He said Ginnie Mae could not make interest payments on behalf or borrowers or negotiate fees with lenders who might be willing to make the changes. "The only viable alternative ... is to require lenders to pay these charges," he said, which would eliminate the incentive to time loan closings to minimize the charges. He said lenders would assume prepayments would occur throughout the month, and would "price new loans at higher levels to reflect their higher costs."
Anderson hopes public pressure will lead to change, which he said "doesn't cost the government anything. It doesn't put money in the pockets of the Realtors; it puts money in the pockets of consumers."