In a letter to HUD Secretary Shaun Donovan dated September 29, 2009, the Federal Reserve Board has reversed its position with respect to the prepayments on FHA loans. Prior to the date of this letter, the staff of the Division of Consumer and Community Affairs of the Federal Reserve Board (the group responsible for issuing official interpretations of Regulation Z) took the position that interest charged on an FHA loan for prepayments made other than on a regularly scheduled payment due date from the date of prepayment until the next installment due date should be treated as a prepayment penalty for disclosure purposes.

In this letter, however, the staff takes the position (consistent with HUD's interpretation) that "(l)enders that engage in this [monthly interest accrual amortization] practice would not be required to treat the interest charged from the date of prepayment until the next installment due date as a prepayment penalty for any purpose under Regulation Z." The letter includes a statement that the letter may be relied upon as an official interpretation of Regulation Z that, under TILA, relieves creditors of liability for actions taken in good faith reliance upon the guidance set forth in the letter to the same extent as if set forth in the commentary to Regulation Z. Because of this definitional change, the FHA-specific TIL disclosure statement (REGZ.FHA) that DocMagic, Inc.'s Compliance Department created to include special prepayment language and implemented in March, 2009 (described in the article below) will be updated to match DocMagic's standard TIL disclosure statement (REGZ4.LSR).

Accordingly, whenever the loan plan or loan type, or both, indicates that the loan transaction is an FHA-loan, a screen shot of the prepayment section of the TIL disclosure statement will look like the below:

FOLLOWING IS DOCMAGIC'S EARLIER ARTICLE ON THIS SUBJECT.

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It's no secret that FHA lending has exploded over the past few months. As a result, we are receiving more questions about FHA loans than at any other time in our 20+ years of operation. This next question regarding prepayment penalties and FHA loans pops up from time to time...it's an interesting one for sure.

It is generally understood that FHA loans do not permit prepayment penalties. However, it is also true that if a borrower prepays in full on a date other than a regularly scheduled due date, the borrower can be required to pay interest up to the next installment date. For example, if a borrower's next regularly scheduled payment due date is April 1, 2009, but the borrower wishes to prepay the loan on March 15, 2009, the borrower can be charged interest for the period from the March 15, 2009 prepayment date through March 31, 2009.

Okay, so what's the rumpus? Well, for Regulation Z purposes, the possibility that additional interest may be charged is treated as a prepayment penalty. Specifically, Regulation Z Section 226.18(k)(1) requires a statement in the TIL disclosure "whether or not a penalty may be imposed if the obligation is prepaid in full." The commentary to Regulation Z Section 226.18(k)(1) provides in relevant part that "penalties include, for example...interest charges for any period after prepayment in full is made."

So the question becomes how to handle this for TIL disclosure statement purposes. Most of our customers drawing documents for FHA loans indicate in the worksheet that there is no prepayment penalty on the loan; the TIL disclosure statement will in turn indicate that no prepayment charge will be assessed. In the past, rarely would an auditor or investor raise an issue with that disclosure. Recently, however, we are hearing of more and more auditors and investors citing this as a problem.

In order to address this issue, we have created an FHA-specific TIL disclosure statement that has been modified to include special prepayment language based on the following commentary by the staff of the Federal Reserve Board to Regulation Z Section 226.17(a)(1):

xi. If a state or Federal law prohibits prepayment penalties and excludes the charging of interest after prepayment from coverage as a penalty, a statement that the borrower may have to pay interest for some period after prepayment in full. The disclosure given under §226.18(k) may state, for example, "If you prepay your loan on other than the regular installment date, you may be assessed interest charges until the end of the month."

A screen shot of the relevant prepayment section of the revised FHA-specific TIL disclosure statement is shown below. Whenever the loan plan or loan type, or both, indicates that the loan transaction is an FHA-loan, the new FHA-specific TIL will be included in the loan package by default.

Click for larger image

Please feel free to contact DocMagic's Compliance Department if you have any questions or comments regarding this article.