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Updated February 04, 2024 Reviewed by Reviewed by Doretha ClemonDoretha Clemons, Ph.D., MBA, PMP, has been a corporate IT executive and professor for 34 years. She is an adjunct professor at Connecticut State Colleges & Universities, Maryville University, and Indiana Wesleyan University. She is a Real Estate Investor and principal at Bruised Reed Housing Real Estate Trust, and a State of Connecticut Home Improvement License holder.
Part of the Series Federal Housing Administration (FHA) LoansUnderstanding FHA Loans
Rules for FHA Loans
Unlike mortgages issued by some traditional lenders, Federal Housing Administration (FHA) loans do not have prepayment penalties.
FHA loans, which are mortgages backed by the government, are designed for low- and moderate-income borrowers. They require lower minimum down payments and credit scores than many traditional loans. Rules governing FHA loans mandate that these mortgages cannot charge any unnecessary fees, such as a due-on-sale clause or prepayment penalty, which may cause financial hardship to borrowers.
A prepayment penalty is assessed if the borrower significantly pays down or pays off the mortgage early, usually within the first three to five years of committing to the loan. The penalty is sometimes based on a percentage of the remaining mortgage balance. It can also be a certain number of months' worth of interest.
Prepayment penalties protect the lender against the financial loss of the anticipated interest income that would otherwise have been paid. They also reduce prepayment risk for investors in fixed-income securities, such as mortgage-backed securities (MBS).
For all FHA loans closed before Jan. 21, 2015, while you are not required to pay extra fees when paying your FHA loan early, you are still responsible for the full interest as of the next installment due date. Even if you paid the full balance of your mortgage, you are still responsible for the interest until the payment due date.
For example, assume the monthly payment due date of your FHA loan is the fifth of every month. If you made your monthly payment by the first of the month, you are still liable for the interest until the fifth.
This post-payment interest charge was not technically a prepayment penalty, but many homeowners felt like it was. To reduce the burden on homeowners, the FHA revised its policies to eliminate post-payment interest charges for FHA loans closed on or after Jan. 21, 2015.
Under these policies, lenders of qualifying FHA loans must calculate monthly interest using the actual unpaid mortgage balance as of the date the prepayment is received. Issuers of FHA loans can only charge interest through the date the mortgage is paid.
Be sure that you have sufficient cash reserves before prepaying an FHA loan. Having enough cash to cover expenses for a few months or even a year is generally a good idea.
Although there are no direct penalties for paying off FHA loans early, there are indirect costs.
Prepaying FHA loans causes borrowers to lose liquidity. Homeowners who put extra cash into their FHA loans will have trouble getting it back out if they need it later. A home equity line of credit (HELOC) is often the best way to get cash out of a home. However, the FHA home loan program does not provide home equity lines of credit, so borrowers will have to turn to other lenders and qualify.
There is also an opportunity cost to prepaying an FHA loan. By paying down the loan, homeowners miss out on the money they could have potentially made investing in other assets.
Finally, at first glance, it seems like losing the mortgage interest tax deduction could be a negative side effect of prepaying an FHA loan. When people using that tax deduction pay off their mortgages early, they no longer get to deduct the interest expense on their taxes. However, the Tax Cuts and Jobs Act (TCJA) increased the standard deduction so much that many taxpayers no longer itemize deductions.
Federal Housing Administration (FHA) loans are federally backed mortgages designed for borrowers who may have lower-than-average credit scores and not enough cash for a big down payment. FHA loans require a lower minimum down payment and credit score than many traditional loans do.
Yes. You can pay off your FHA mortgage early. Unlike many traditional mortgages, FHA loans do not charge prepayment penalties.
Lenders charge prepayment penalties to offset the financial loss of the interest income that they would have been earned over the term of the mortgage.
Article SourcesUnderstanding FHA Loans
Rules for FHA Loans
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Up-front mortgage insurance (UFMI) is a type of mortgage insurance policy made at the time of the loan. It is required on certain FHA loans.
Cross collateralization is the act of using one asset as collateral to secure multiple loans or multiple assets to secure one loan.
A workout agreement renegotiates the terms of a loan to provide a measure of relief to the borrower.A principal reduction is a decrease in the principal owed on a loan, typically a mortgage, as an alternative to foreclosure on the home.
A reverse mortgage initial principal limit is the amount of money a reverse mortgage borrower can receive from the loan.
Hypothecation occurs when an asset is pledged as collateral to secure a loan without giving up title, possession, or ownership rights.
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