How to Fix the Festering Sore of Daily Interest Mortgages

August 24, 2018

A major purpose of the Dodd/Frank bill enacted after the financial crisis was to create a new consumer protection agency, which would have as one of its major goals an improved system of mandatory disclosures to mortgage borrowers. The Consumer Financial Protection Bureau (CFPB) is now in its eight year and has yet to recognize, let alone fix, an insidious practice by some mortgage lenders of charging interest daily instead of monthly and not disclosing this in any way that a borrower would understand.

In a recent article on this subject, I pointed out that borrowers who had  daily interest mortgages but didn’t realize it can easily find that their loan payoff date keeps moving further and further away. Neither the CFPB’s new Loan Estimate disclosure, designed for shoppers, or its Closing Disclosure for borrowers, reveal whether interest is calculated daily or monthly.

That article also indicated that, at some point, I would indicate how this festering sore of the mortgage system could be fixed. That is the purpose of this article.    

On new loans, both the disclosures referred to above should indicate whether the loan accrues interest daily or monthly. If it is daily, the disclosure should include the daily rate, an illustration of how it is calculated, an explanation of how the monthly payment is allocated between interest and principal, and an explanation of the interest deficit account. In addition, both disclosures should have a table that shows when the daily rate loan will be paid off if the borrower consistently pays 1, 3, and 5 days late, and 1, 3, and 5 days early.

It is possible that these disclosure requirements will mean that no more daily interest mortgages will be written. If the only rationale for these mortgages was that they allowed borrowers to be hoodwinked, that is what we would expect to happen. However, some borrowers can make good use of daily interest mortgages and would select them if given the choice. This is why the preferred remedy for abuse is disclosure rather than prohibition.

Existing daily interest mortgages present a very different problem because the damage already done can’t be undone. However, further damage can be limited by mandated changes in servicing system disclosures. The core requirement should be that the daily interest accrual feature should be obvious rather than obfuscated.  Showing total interest for the month without any indication of how it is calculated is obfuscation and should not be permitted.

Since the prospects are not bright for a public policy fix anytime soon, existing borrowers with daily interest mortgages are on their own. To help them, I have a daily interest spreadsheet on my web site – it is called Monitoring Amortization of a Simple Interest Loan. Borrowers can use it to reproduce the day-to-day history of their mortgage, or they can proceed as if the loan is a new one by using the most recent balance as the loan amount. If they elect that option, the payment amount would remain as it was. In entering future payments, users must take care to enter them on the day they are posted by the lender, not the day they were sent.

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