On March 13, 2014, HUD published a proposal to eliminate the requirement that an FHA loan borrower be required to pay interest after the loan is prepaid. The move is needed because the requirement would effectively cause FHA loans to be prohibited under CFPB rules starting in January 2015. Comments on the proposal are due by May 12, 2014.
Based on the use of monthly interest accrual amortization with FHA loans, if an FHA loan is prepaid on a date that is not a regular payment due date the borrower must pay interest through the end of the month even though the loan has been paid off. In connection with the adoption of the Regulation Z ability to repay rule and modifications to the Regulation Z high-cost loan provisions that became effective in January 2014, the CFPB revised the definition of “prepayment penalty” to provide that interest charged consistent with the monthly interest accrual amortization method is not a prepayment penalty for FHA loans consummated before January 21, 2015, but is a prepayment penalty for loans consummated on or after such date.
The revised definition of “prepayment penalty” restored the application to FHA loans of a prior Fed position on such penalties. Shortly before the higher-priced mortgage loan provisions became effective in October 2009, the prior position was clarified to exclude FHA loans to avoid an unintended consequence that would have prohibited the making of any FHA loan if it would be a higher-priced mortgage loan.
The ability to repay rule also imposes significant limits on when a loan may be subject to a prepayment penalty, and prohibits a penalty that could be imposed more than 36 months after consummation or that would exceed certain amounts. Also, the modifications to the high-cost loan provisions include (1) a new prepayment penalty trigger under which the provisions apply to a loan if a prepayment penalty could be imposed more than 36 months after consummation or could exceed a certain amount, and (2) a complete prohibition against a high-cost loan being subject to a prepayment penalty (prior law permitted certain prepayment penalties). The combination of these changes and the changes to the definition of “prepayment penalty” will effectively prohibit the further origination of FHA loans commencing January 21, 2015, unless the requirement to pay interest after a prepayment is eliminated.
During the rulemaking process, the CFPB and HUD conferred regarding the prepayment penalty issue and negotiated an arrangement under which a requirement to pay interest after a prepayment of an FHA loan would once again be considered a prepayment penalty, but the change would not apply for FHA loans consummated before January 21, 2015 in order to provide HUD with the time to modify its rules.