For years it was widely considered a massive, government-sanctioned rip-off of home mortgage borrowers. Then it was banned by the Consumer Financial Protection Bureau. And now it’s the subject of class-action suits that accuse four large banks of illegally collecting millions of dollars in excess mortgage interest payments from their customers.
The source of all the controversy: The Federal Housing Administration’s longtime policy of allowing banks to charge homeowners a full month’s worth of interest when they went to pay off their FHA-insured loans – even after they had paid back all the principal they owed.
To illustrate: Say you were preparing to pay off your mortgage balance in full on May 3. Under the government’s policy, lenders were permitted to charge you interest on the paid balance though May 31, collecting it at the closing May 3. It was the equivalent of being charged for a full tank of gas, even though all you pumped was three gallons.
The official rationale for the controversial policy was that mortgage bond investors expected full months’ worth of interest payments on FHA loans, not partial payments. Unless borrowers paid off their loans on the first of the month, the lender could charge them interest for the full month. But FHA was alone in its stance on this. Neither of the two giant mortgage players, Fannie Mae and Freddie Mac, forced consumers to make extra interest payments on loans to please Wall Street. Nor did the Department of Veterans Affairs (VA) do so on its home mortgages. FHA officials also argued that because of the opportunity lenders have to charge additional interest, they typically quote more favorable interest rates on FHA loans – 0.10% to 0.15% lower – compared with non-FHA loans.
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Last year, after the CFPB ruled that FHA’s policy amounted to a prepayment penalty prohibited by federal law, FHA rescinded the policy for new borrowers taking out loans on or after Jan. 21, 2015, but kept it in place for an estimated 7.8 million homeowners who had FHA loans dating to previous years. At the same time, the agency conceded that the savings FHA borrowers supposedly received from its policy were illusory, and that “in most cases” the extra interest payments exceeded any small interest rate break upfront.
In a series of recent legal moves, attorneys representing FHA borrowers sued Bank of America, Wells Fargo Mortgage, U.S. Bank and SunTrust Mortgage for allegedly failing to properly disclose the extra-interest policy to clients paying off loans originated before the deadline. All four banks, according to complaints filed in federal district courts in Florida and Georgia, violated FHA’s own rules by using payoff disclosure forms that were not approved by FHA and did not adequately advise borrowers on how to limit or avoid extra-interest charges. The approved FHA disclosure expressly informs borrowers that “it is to your advantage” to schedule closings either at the end of the month or by the first business day of the month.
The net effect of the allegedly improper disclosures, the suits charge, is that large numbers of borrowers paid more in interest than they could have, and that the four banks collected substantial sums in post-payment interest illegally on FHA mortgages.
All four banks declined comment on the suits when I contacted them.
Real estate industry estimates of excess FHA interest charges over the past decade and a half have ranged into the hundreds of millions of dollars per year. In 2003 alone, according to one estimate from the National Association of Realtors, FHA borrowers paid nearly $587.4 million in excess interest.
One of the plaintiffs in the class-action suits, a homeowner in Florida who allegedly was overcharged by Wells Fargo, claimed in her suit that the bank informed her in a loan payoff statement that she would owe $1,227.68 interest. Yet her typical monthly interest charge was just $613.84. Wells Fargo’s payoff statement was not in the format approved by FHA, she said, and was “both misleading and confusing” and did not properly advise her of her options.
One of the attorneys representing the plaintiffs, Naveen Ramachandrappa of Bondurant Mixson & Elmore in Atlanta, said the suits reveal that the four lenders “took hundreds of millions of dollars in illicit profits” by not following the rules, and “those funds need to be returned to plaintiffs” and to other borrowers who have been victims across the country.