On August 26, 2014, the U.S. Department of Housing and Urban Development (HUD) issued a final rule to allow FHA-approved lenders to charge an FHA loan borrower interest only through the date the loan is prepaid. The final rule also prohibits the charging of interest beyond that date. The revised rule is needed because under the existing rule, FHA loans would be prohibited under the new CFPB rules starting in January 2015. As we previously reported, HUD published a proposed rule on March 13, 2014. The final rule adopts the proposed rule without change and is effective January 21, 2015.

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 adopting 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 include a requirement to pay interest on the loan “balance” after the loan is prepaid in full (because the “balance” is still treated as being outstanding), but excepted from the definition FHA loans consummated before January 21, 2015.

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:

• 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
• 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” would have effectively prohibited the further origination of FHA loans commencing January 21, 2015, unless the requirement to pay interest after a prepayment was eliminated.

Notably, 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. The change would not apply, however, for FHA loans consummated before January 21, 2015, to provide HUD sufficient time to modify its rules.