May 22, 2024

Why You Should Always Pay Off An FHA Mortgage At The End Of The Month

Many FHA borrowers are needlessly paying extra interest charges by paying off an FHA mortgage before the end of the month.  The reason behind the extra interest charges is due to the method by which the FHA calculates the final interest charges due on an FHA loan payoff.

For all other types of mortgages that are paid off, a borrower is charged for interest to the date that the loan is 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 balance outstanding.   This is an equitable method since the borrower is only paying interest for the exact amount of days that the loan is outstanding.

As an example, a borrower with a conforming loan who decides to refinance or sell his home on the fifth day of the month and is up to date on his mortgage payments, will only pay interest for five days.  If the loan balance outstanding is $200,000 and the rate is 5%, the per diem interest due is $27.40.  The borrower would pay total interest of $137 for the five days that the loan is outstanding.

The FHA calculates the interest due on a loan payoff in a totally different manner.  Regardless of what day of the month an FHA loan is paid off, the borrower is charged for a full month’s interest.  Most FHA borrowers, totally unaware of how final interest charges are calculated, could wind up paying stiff excess interest charges without even being aware of it.

In a simplified example, a borrower who pays off an FHA loan on the first of the month will be charged interest for the entire month even though the loan was paid off at the beginning of the month.  On a $200,000 FHA loan at 5% which is paid off on the first of the month, the borrower will be charged accrued interest for the entire month.  Instead of paying interest of $27.40 that would be due on a conforming loan payoff, an FHA borrower could be charged as much as $822.

Most reputable lenders are aware of this unique feature of FHA loans and will advise a customer to close at the end of the month to avoid the excess interest charges.  Many times, however, a borrower will not be able to time a closing at month end and is forced to pay the extra interest charges.

In order to remedy this inequitable situation, two senators recently introduced a bill, S.488 – Reduce Excessive Interest Payments Act, which would require that the FHA charge interest on a loan payoff on a per diem basis.  The prospects for the passage of the bill remain unknown at this point although various housing industry groups have lent their support to the bill.

At the present time, the only way to avoid excessive interest charges on the payoff of an FHA loan is to make sure that the closing takes place at the end of the month.  Unfortunately, most borrowers are unaware of the “interest trap” involved when paying off an FHA loan and are needlessly paying excessive interest.