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2.5 Interest Overcharges

Interest overcharges can result when servicers inappropriately charge for interest not yet accrued, calculate interest in ways that are not authorized by the contract,65 or charge interest prohibited by law.66

Several accounting methods are used to calculate the amount of interest due on mortgage loans. Conventional mortgage loans67 generally use what is called the scheduled method of accounting. On a “scheduled loan,” for purposes of determining how much interest is due on the loan, each payment is counted as if it were made on the date that it is scheduled to be paid. This means that whether the payment is received on the first day, the third day, or the seventeenth day of the month, the same amount of interest is charged for that month. For scheduled loans, the interest to be paid over the life of the loan is determined when the loan is made. The only event that will alter the predicted amortization of the mortgage is an unscheduled change in the principal amount, either through prepayments of principal or additions to principal (for example, negatively amortizing loans).

In contrast, under the daily accrual method of accounting, the amount of interest due is determined during the term of the loan, rather than at the time the loan is established or at the time of prepayment.68 Lenders who use this method charge interest based upon the actual number of days between payments. In other words, the annual interest rate shown on the promissory note is divided by 360 or 36569 to determine the daily rate, and this daily rate is multiplied by the number of days elapsed between payments.

In certain circumstances some methods are significantly more disadvantageous to the consumer than others. For example, the daily accrual method can be especially problematic for consumers who consistently make late payments and payments at odd intervals. While daily accrual loans have been used by some subprime lenders to extract more money from borrowers, it is important to note that this method of charging interest is not per se unfair or unlawful. In fact, for borrowers who consistently make payments early this accounting method can be beneficial.

Scheduled or daily accrual loan? The language of the note and mortgage (or deed of trust) governs the applicable accounting method. For example, the Fannie Mae/Freddie Mac Uniform Note includes the following language: “Each monthly payment will be applied as of its scheduled due date and will be applied to interest before Principal”70 (emphasis added). This or similar language indicates that the loan is a “scheduled loan.” Daily accrual loans will typically contain the following or similar language: “Interest will be calculated assuming a 365-day year and will be charged on that part of the principal which has not been paid, for the actual number of days elapsed.” In rare cases, the note or security instrument may not give any indication of which accounting method should be used. This situation requires a careful analysis of the loan history to determine the method used by the servicer.71

In addition to determining the method of accounting, challenging the interest charged on a mortgage loan may also require a determination of the use of a 360-day versus 365-day year, the extent of proper rounding, and whether compounding interest is permissible. There may also be questions about whether interest can be charged on items not included in the original loan balance, such as late fees, escrow advances, and attorney fees.72 Many of these issues are discussed in detail in NCLC’s Consumer Credit Regulation.73

Footnotes

  • 65 {63} See Cortez v. Keystone Bank, 2000 WL 536666 (E.D. Pa. May 2, 2000) (allegation of overcharge of interest in home equity line of credit state claim for breach of contract and violation of RESPA); Allenson v. Hoyne Sav. Bank, 651 N.E.2d 573 (Ill. App. Ct. 1995) (plaintiff’s allegations of mistaken amortization scheme resulting in overcharges sufficient to support RICO claim).

  • 66 {64} For example, the Servicemembers Civil Relief Act mandates a reduction of the interest rate on pre-active duty obligations, including mortgages, to six percent for certain active duty military personnel and their families. See National Consumer Law Center, Home Foreclosures § 5.14 (2019), updated at www.nclc.org/library.

  • 67 {65} See National Consumer Law Center, Mortgage Lending § 2.3.1 (3d ed. 2019), updated at www.nclc.org/library (describing different types of loans).

  • 68 {66} For more on daily accrual loans, see National Consumer Law Center, Mortgage Lending § 2.3.4 (3d ed. 2019), updated at www.nclc.org/library.

  • 69 {67} Rather than divide the annual rate by 365, creditors often prefer to divide the annual rate by 360 days, and assume that all monthly periods have thirty days. See National Consumer Law Center, Mortgage Lending § 2.5.3 (3d ed. 2019), updated at www.nclc.org/library; National Consumer Law Center, Consumer Credit Regulation §§ 5.5.4.2 to 5.5.4.4 (3d ed. 2020), updated at www.nclc.org/library.

  • 70 {68} See Fannie Mae/Freddie Mac Single-Family Uniform Instruments, Form 3200: Multistate Fixed Rate Note, at 3 (Jan. 2001), available at www.freddiemac.com.

  • 71 {69} See National Consumer Law Center, Mortgage Lending Ch. 8 (3d ed. 2019), updated at www.nclc.org/library.

  • 72 {70} In re Crowley, 293 B.R. 628 (Bankr. D. Vt. 2003) (clause in note providing that “the Maker must pay interest on all amounts not paid when due, at the legal rate” did not entitle lender to interest on late fees, because there is no due date for late fees).

  • 73 {71} National Consumer Law Center, Consumer Credit Regulation Ch. 4 (3d ed. 2020), updated at www.nclc.org/library.