Can a state law stop a mortgage lender from collecting interest in advance at closing?

Plain-English summary

Maryland's Community Development Administration, which helps first-time homebuyers get below-market mortgage loans through participating lenders, asked the Attorney General whether a 1986 state law barring lenders from collecting interest in advance still applied to first mortgage loans, or whether it had been overridden by a federal law. The state provision, CL §12-103(b)(1)(vi), let mortgage lenders charge market-rate interest on first mortgages, but only if they did not require "odd days" interest, the interest that accrues between the loan's closing date and the start of the first full month, to be paid up front at closing. The Attorney General concluded that this state restriction had been preempted by §501 of the federal Depository Institutions Deregulation and Monetary Control Act of 1980, a law that stripped state usury limits from federally related mortgage loans on residential property, because Maryland had never adopted the specific override language DIDMCA required for a state to keep its own limits in place. As a result, the opinion concluded, lenders making loans covered by DIDMCA could still require borrowers to pay the odd-days interest at closing, despite the state statute.

Currency note

This opinion was issued in 1988. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

Common questions

Could Maryland stop mortgage lenders from requiring interest to be paid in advance at closing?
Not for loans covered by DIDMCA, according to this opinion. The Attorney General concluded that CL §12-103(b)(1)(vi)'s ban on requiring advance payment of "odd days" interest was a limit on the amount of interest a lender could receive, which fell within the category of state usury restrictions that federal law preempted for federally related first mortgage loans.

Why didn't Maryland's own law override the federal preemption?
The opinion concluded that DIDMCA only let a state keep its usury limits in place if the state adopted, between April 1, 1980 and April 1, 1983, a law that specifically referred to the federal Act and stated the state's intent to override it. Maryland's relevant amendments, in 1981, 1982, and 1986, never mentioned the federal law at all, so no valid override occurred.

Were all limits on mortgage lender charges preempted by the federal law?
No. The opinion concluded that provisions "designed to protect borrowers," like limits on prepayment penalties, attorneys' fees, or late charges, were not preempted, citing a federal regulation exempting those kinds of borrower protections. But it concluded the odd-days interest rule was different because it directly reduced the value of ordinary loan interest rather than capping an ancillary fee or penalty.

Background and statutory framework

The opinion explained that Maryland law generally caps the effective interest rate lenders can charge, but CL §12-103(b)(1) created an exception letting lenders charge market-rate interest on loans secured by a first mortgage or deed of trust on residential property, so long as the loan met several conditions. One of those conditions, added by Chapter 628 of the Laws of Maryland 1986, barred a lender from requiring "payment of any interest in advance except any points permitted" under the statute. Before that amendment, it had been common practice for mortgage lenders to collect the "odd days" interest, the interest accruing between a loan's closing and the start of the first full payment month, at closing, which let lenders write loan documents with even monthly installments.

Applying the federal preemption framework, the opinion read DIDMCA §501(a)(1) as expressly displacing state constitutional or statutory limits on "the rate or amount of interest, discount points, finance charges, or other charges" for federally related first mortgage loans on residential property, while a federal regulation, 12 C.F.R. §590.3(c), preserved state law limits on charges "designed to protect borrowers," such as prepayment penalties, attorneys' fees, or late charges. The opinion concluded Maryland had never validly opted out of the federal preemption, since DIDMCA §501(b)(2) required a state override adopted between April 1, 1980 and April 1, 1983 that specifically referenced the federal statute, and none of Maryland's relevant amendments to CL §12-103 (in 1981, 1982, or 1986) mentioned DIDMCA at all.

The opinion then reasoned that the odd-days interest rule was not the kind of borrower protection exempt from preemption, unlike prepayment penalties or late fees, which are ancillary charges unrelated to the loan's actual cost of credit, the odd-days interest is ordinary interest on the loan itself, just for a partial first month. Delaying when a lender could collect that interest reduced its economic value to the lender, which the opinion treated as an effective limit on "the amount of interest ... received," squarely within DIDMCA's preemption. The opinion also pointed to DIDMCA's legislative history and purpose, tracing Congress's concern that state usury laws capping mortgage rates below market levels during a period of high interest rates were driving mortgage capital out of affected states and undermining national housing policy, and concluded that Maryland's odd-days interest rule risked the same kind of market disruption DIDMCA was meant to prevent, even if on a smaller scale than an outright rate cap.

Citations and references

Statutes:

• CL §12-103(b)(1)
• CL §12-103(b)(1)(i)
• CL §12-103(b)(1)(iii)
• CL §12-103(b)(1)(vi)
• CL §12-101(d)
• CL §12-101(h)
• CL §12-108
• Chapter 628 of the Laws of Maryland 1986
• Chapter 752 of the Laws of Maryland 1982
• Chapter 2 of the Laws of Maryland 1981
• DIDMCA §501(a)(1)
• DIDMCA §501(a)(1)(C)
• DIDMCA §501(b)(2)
• DIDMCA §501(b)(4)
• 12 U.S.C. §1735f-7
• 12 U.S.C. §1735f-5
• 12 C.F.R. §590.3(c)
• 12 C.F.R. §226.22(a)(1)
• 12 C.F.R. §226.4(a)
• 15 U.S.C. §1606
• 15 U.S.C. §1605(a)

Cases:

• B.F. Saul Co. v. West End Park North, Inc., 250 Md. 707, 714, 246 A.2d 591 (1968)
• Lindenberg v. First Federal Savings & Loan Association, 528 F.Supp. 440, 446-47 (N.D. Ga. 1981)
• Bank of New York v. Hoyt, 617 F.Supp. 1304, 1309 (D.R.I. 1985)
• Doyle v. Southern Guaranty Corp., 795 F.2d 907, 911 (11th Cir. 1986)
• Quiller v. Barclays American/Credit, Inc., 764 F.2d 1400, 1403 (11th Cir. 1985) (Hill, J., dissenting)

Source

• Landing page: https://oag.maryland.gov/resources-info/Pages/attorney-general%E2%80%99s-opinions.aspx
• Original PDF: https://oag.maryland.gov/resources-info/Documents/pdfs/Opinions/1988/Volume73_1988.pdf

Original opinion text

Best-effort transcription from a scanned PDF. Minor errors may remain, the linked PDF is authoritative.

FINANCIAL INSTITUTIONS

First Mortgage Loans—Federal Preemption—Maryland Statute Prohibiting a Lender From Requiring Advance Payment of Interest Is Preempted by Federal Law.

April 5, 1988

Mr. William Beans, Director
Home Ownership Programs
Community Development Administration
Department of Housing and Community Development

You have requested our opinion on whether §12-103(b)(1)(vi) of the Commercial Law Article ("CL" Article), which prohibits a lender from requiring advance payment of interest on a first mortgage loan, has been preempted by §501 of the federal Depository Institutions Deregulation and Monetary Control Act of 1980 ("DIDMCA").1
For the reasons given below, we conclude that the State law provision has been preempted by federal law and, accordingly, lenders who make loans secured by first mortgages on residential property to which the DIDMCA applies may not be prohibited from collecting interest in advance at the time of loan closing.2

                                    I
                             Background

The Community Development Administration ("CDA") issues tax-exempt mortgage revenue bonds to finance the purchase of homes by first-time homeowners at rates of interest below the market rate. CDA relies upon financial institutions around the State for the origination and closing of these mortgage loans, and it provides these lenders with mandatory loan closing documents that conform to legal requirements.

1
DIDMCA §501 has never been codified, but is found in a note following 12 U.S.C. §1735f-7.
2
We thus concur in the views expressed by the General Counsel for the Federal Home Loan Bank Board. Letter from Harry W. Quillian, General Counsel, to Assistant Attorney General Francis X. Pugh (May 8, 1987).

Maryland law generally sets limits on the effective rate of simple interest that lenders may charge for various types of loans.3 However, CL §12-103(b)(1) permits lenders to charge "interest at any effective rate of simple interest" on a loan secured by a first mortgage or first deed of trust on residential real property, under certain circumstances. By that exception, mortgage lenders are allowed to charge interest at the market rate, but are required to conform their loans to stated conditions. One of those conditions is that "[t]he lender does not require payment of any interest in advance except any points permitted under this subtitle ['Interest and Usury']." CL §12-103(b)(1)(vi).4 That condition was added by Chapter 628 of the Laws of Maryland 1986.
In the past, it has been the practice of mortgage lenders to require the borrower to pay, at the time of the loan closing, the amount of interest on the loan that will accrue between the closing date and the beginning of the first full month. This practice made it possible to recite even monthly installments of principal and interest in the deed of trust note used in connection with CDA loans. However, the enactment of CL §12-103(b)(1)(vi) effectively prohibited lenders from requiring that interest for the partial month, or "odd days," be paid in advance. Accordingly, CDA has furnished to its lenders mandatory loan closing documents that do not provide for advance payment of a partial month's interest.

                                         II
                   DIDMCA Preemption Provisions

DIDMCA §501(a)(1) expressly preempts State usury laws applicable to first mortgages on residential property: "The provisions of the constitution o[r] the laws of any State expressly limiting the rate or amount of interest, discount points, finance charges, or other charges

3
"'Effective rate of simple interest' means the yield to maturity rate of interest received or to be received by a lender on the face amount of a loan," except that any interest charged at or before the inception of a loan contract is deducted from the face amount to determine the principal of the loan, for the purpose of calculating the effective rate of simple interest. CL §12-101(d).
4
"'Point' means a fee, premium, bonus, loan origination fee, service charge, or any other charge equal to 1 percent of the principal amount of a loan which is charged by the lender at or before the time the loan is made as additional compensation for the loan." CL §12-101(h). The circumstances under which a lender may charge points are set forth in CL §12-108.

which may be charged, taken, received, or reserved shall not apply to any loan, mortgage, credit sale, or advance" that is secured by a first lien on residential real property.5 However, regulations adopted by the federal Home Loan Bank Board make it clear that the DIDMCA does not preempt "limitation[s] in state laws on prepayment charges, attorneys' fees, late charges or other provisions designed to protect borrowers." 12 C.F.R. §590.3(c).6
DIDMCA §501(b)(2) authorizes states to override the federal preemption of their usury laws.7 To do so, a state must adopt, between April 1, 1980 and April 1, 1983, a provision "which states explicitly

5
DIDMCA §501(a)(1) applies to all "federally related mortgaged loans," as described in 12 U.S.C. §1735f-5 and as that description is expanded by DIDMCA §501(a)(1)(C). Thus, the preemption applies to any loan that is:
(1) Secured by residential real property, stock in a residential cooperative housing corporation, or a first lien on a manufactured home; and
(2) Made by a lender insured or regulated by an agency of the federal government, approved by the Secretary of Housing and Urban Development for participation in a mortgage insurance program under the National Housing Act, or who is an individual financing the sale or exchange of the individual's principal residence; or
(3) Made, insured, guaranteed, supplemented, or assisted in any way by an officer or agency of the federal government or under or in connection with a housing, urban development, or related program administered by a federal officer or agency; or
(4) Eligible for purchase by the Federal National Mortgage Association, the Government National Mortgage Association, or the Federal Home Loan Mortgage Corporation or is from a financial institution from which it could be purchased by the Federal Home Loan Mortgage Corporation; or
(5) Made by a creditor who makes or invests in residential loans including loans or credit sales secured by first liens on manufactured homes, aggregating more than $1,000,000 per year; or
(6) Made by any creditor who sells manufactured homes financed by loans or credit sales, if the creditor has an arrangement to sell or does sell the loans or credit sales to another lender, institution, or creditor that does make or invest in residential real estate loans or loans or credit sales secured by first liens on manufactured homes aggregating more than $1,000,000 per year.
6
This regulation codifies a statement in the legislative history that DIDMCA §501(a)(1) was not intended to preempt "limitations on prepayment charges, attorney fees, late charges, or similar limitations designed to protect borrowers." S. Rep. No. 368, 96th Cong., 2d Sess. 19, reprinted in 1980 U.S. Code Cong. & Admin. News 236, 255.
7
DIDMCA §501(b)(4) permits states, at any time after March 31, 1980, to "adopt a provision of law placing limitations on discount points" charged in connection with residential mortgages. CL §12-103(b)(1)(vi) clearly is not such a provision, points are expressly exempted from its operation.

and by its terms that such State does not want the provisions of subsection (a)(1) to apply with respect to loans, mortgages, credit sales, and advances made in such state." To be effective, any state override provision must be very specific:

Under this requirement the state law, constitutional provision, or other override proposal must specifically refer to this Act and indicate that the state intends to override the federal preemption this Act provides. Since each of the [DIDMCA's] federal preemptions provides for a separate right of state override, the state's override proposal would be required to refer to the specific preemption, such as that on mortgage loans

S.Rep. No. 368, 96th Cong., 2d Sess. 79, reprinted in 1980 U.S. Code Cong. & Admin. News 236, 309.
CL §12-103 was amended during the period between April 1, 1980 and April 1, 1983 by Chapter 752 of the Laws of Maryland 1982, but that enactment made no reference to federal law.8 The prohibition against requiring payment of interest in advance was enacted by Chapter 628 of the Laws of Maryland 1986, long after the period set by DIDMCA §501(b)(2); Chapter 628 also made no reference to the federal law.
In light of the specificity required for a State law override of the federal preemption, it is clear that Maryland has not overriden the federal preemption. Therefore, if CL §12-103(b)(1)(vi)'s prohibition against requiring the payment of interest in advance is a limit on the "rate or amount of interest, discount points, finance charges or other charges," it has been preempted by federal law. If, however, it is a provision "designed to protect borrowers," like a limitation on prepayment charges, attorneys' fees, or late charges, it is exempt from preemption under 12 C.F.R. §590.3(c).

                                      III
               Exemption from Federal Preemption

The provisions of CL §12-103(b)(1) are in part designed to protect borrowers. For example, CL §12-103(b)(1)(i) requires a written agreement

8
Chapter 2 of the Laws of Maryland 1981 also amended CL §12-103, but that enactment made only technical corrections and was not intended to affect any substantive law.

signed by the borrower setting forth the rate of interest charged, and CL §12-103(b)(1)(iii) prohibits the imposition of prepayment penalties. Those provisions clearly are not preempted. 12 C.F.R. §590.3(c). The prohibition against requiring payment of interest in advance was enacted as part of an effort to reduce closing costs for home buyers. However, we think that it is not the kind of provision to which federal preemption is inapplicable.
Prepayment charges, attorneys' fees, and late charges are not interest on the loan itself, but ancillary fees or penalties. That is, they do not reflect the actual cost of credit, but incidental expenses that a lender may incur in handling a loan, for example, in processing a payment made early or late. Hence, restrictions on the amount of those fees or penalties protect borrowers from being required to pay undue amounts in penalties or incidental expenses not related to the cost of credit.
The "odd days" interest addressed by CL §12-103(b)(1)(vi), in contrast, is not such an ancillary expense. Rather, it is normal interest on the loan for the period between the loan closing date and the beginning of the first full month. Moreover, the prohibition against requiring payment of that interest in advance was not enacted to protect consumers from an unduly large fee or penalty, but to postpone the date on which they may be required to pay interest actually accruing on the loan itself. Therefore, we believe that CL §12-103(b)(1)(vi) is not exempt from federal preemption under 12 C.F.R. §590.3(c).9

                                        IV
                  Preemption of CL §12-103(b)(1)(vi)

A. Effect of CL §12-103(b)(1)(vi)
CL §12-103(b)(1)(vi) is not a direct restriction on the rate of interest that may be charged for a loan secured by a residential mortgage:

9
For much the same reason, we think that "odd days" interest is not the equivalent of discount points, which may be limited under DIDMCA §501(b)(4). A point is a fee or charge imposed in addition to the interest payable over the term of the loan and designed, in general, to recoup the lender's administrative or operating costs in negotiating a loan. See CL §12-101(h); B.F. Saul Co. v. West End Park North, Inc., 250 Md. 707, 714, 246 A.2d 591 (1968). That "odd days" interest is not an additional charge, but only the application of the normal interest on the loan to a portion of the loan's term, is illustrated by the difference in practical effects of points and "odd days" interest. The amount of money that a lender receives as a point does not vary with the length of time between the closing date and the beginning of the first full month. The amount of money received as "odd days" interest does, of course, vary according to the length of time to which it applies, just as the total amount received as interest on the entire loan varies with the term of the loan.

The amount of "odd days" interest due is calculated at the rate that applies to the full term of the loan, which the lender is authorized to set at the market rate. The State law provision regulates only the time at which interest on the "odd days" portion of the loan may be collected.
However, the time when a payment is received necessarily affects its value to the lender because the ability to make use of or receive interest on money during a given time is itself of value to the recipient. Thus, by delaying the date when interest for "odd days" may be received, CL §12-103(b)(1)(vi) decreases the effective value of that interest to the lender. In our view, CL §12-103(b)(1)(vi) is therefore an effective limit on "the amount of interest, discount points, finance charges, or other charges which may be ... received" by the lender.

B. Legislative Intent
Further, the legislative history of the federal preemption provision clearly states Congress's intent to preempt limitations on all charges that are included in the "annual percentage rate." S.Rep. 368, 96th Cong., 2nd Sess. 19, reprinted in 1980 U.S. Code Cong. & Admin. News 236, 255. The annual percentage rate, which the Truth in Lending Act requires be disclosed in connection with any extension of consumer credit, reflects the amount of the finance charge for the credit. 15 U.S.C. §1606.10 The finance charge is "the sum of all charges, payable directly or indirectly by the person to whom the credit is extended, and imposed directly or indirectly by the creditors as an incident to the extension of credit." 15 U.S.C. §1605(a). Clearly, the interest charged for the period between the closing of the loan and the beginning of the first full month is a part of the finance charge for the loan. Accordingly, we believe that, because CL §12-103(b)(1)(vi) effectively reduces the value of "odd days" interest, it is within the intended scope of DIDMCA §501(a)(1).

C. Purpose of DIDMCA §501
To be sure, the decrease in effective value of the "odd days" interest in any particular case may be small. But the overall effect of the

10
The regulations adopted under the Truth and Lending Act define "annual percentage rate" as "a measure of the cost of credit, expressed as a yearly rate, that relates the amount and timing of value received by the consumer to the amount and timing of payments made." 12 C.F.R. §226.22(a)(1). The term "finance charge" means "the cost of consumer credit as a dollar amount." 12 C.F.R. §226.4(a).

provision may be significant for a lender that issues large numbers of mortgage loans or for which mortgage lending is a major part of the lender's business. Therefore, we believe that construing DIDMCA §501(a)(1) as applicable to the prohibition against requiring the payment of interest in advance comports with the purpose for which the federal preemption was enacted.
Mortgage lenders typically carry large portfolios of outstanding mortgages issued over a number of years. When market rates of interest are volatile, lenders may face a large negative difference between the market interest rates and the average rates of mortgages in their portfolios. To avoid loss in a volatile interest market, lenders must have the ability to issue new loans at market rates. Patently, state usury laws that restrict lenders to below-market rates restrict their ability to participate successfully in the mortgage lending market. Lindenberg v. First Federal Savings & Loan Association, 528 F.Supp. 440, 446-47 (N.D. Ga. 1981).
The DIDMCA was enacted during such a period of rapidly escalating market interest rates. The Senate Banking, Housing, and Urban Affairs Committee's Report on the legislation explained the adverse effects at the national level that State usury laws can have under those circumstances:

     [W]here state usury laws require mortgage rates below market levels of interest, mortgage funds in those states will not be readily available and those funds will flow to other states where market yields are available. This artificial disruption of funds availability not only is harmful to potential home buyers in states with such usury laws, it also frustrates national housing policies and programs.
     A stable home financing system was the principal reason for the establishment by the federal government of the FHA and VA programs, the federal chartering of savings and loan associations, and the national secondary market mechanisms.

   The Committee believes that this limited modification in state usury laws will enhance the stability and viability of our nation's financial system and is needed to facilitate a national housing policy and the functioning of a national secondary market in mortgage lending.

S.Rep. No. 368, 96th Cong., 2d Sess. 19, reprinted in 1980 U.S. Code Cong. & Admin. News 236, 254-55.

DIDMCA §501 was specifically enacted "to ease the severity of the mortgage credit crunches of recent years" by removing artificial disruptions in the national mortgage lending market caused by restrictive state laws. Id., reprinted in 1980 U.S. Code Cong. & Admin. News 254. See also Bank of New York v. Hoyt, 617 F.Supp. 1304, 1309 (D.R.I. 1985). DIDMCA was intended to apply broadly, to facilitate the free flow of capital for homebuying into all states. Doyle v. Southern Guaranty Corp., 795 F.2d 907, 911 (11th Cir. 1986). It was expected that the law would "assist both borrowers and lenders by freeing up additional credit for housing." Quiller v. Barclays American/Credit, Inc., 764 F.2d 1400, 1403 (11th Cir. 1985) (Hill, J., dissenting).
Because CL §12-103(b)(1)(vi) reduces the value of "odd days" interest, it has the potential to render the Maryland mortgage market less attractive to lenders. To be sure, its effect is unlikely to be as severe as that of a state law setting mortgage rates at a level below the market rate for the entire period of the loan. Nonetheless, we think that it may create the kind of artificial disruption in the market that DIDMCA was intended to prevent.

                               V
                          Conclusion

In summary, it is our opinion that CL §12-103(b)(1)(vi) is a limitation on the amount of interest that a lender may receive for a loan secured by a first mortgage on residential property. As such, it is preempted by DIDMCA §501(a)(1). Accordingly, lenders who make loans secured by first mortgages on residential property may not be prohibited from collecting interest in advance at the time of loan closing.

        J. Joseph Curran, Jr., Attorney General
        C.J. Messerschmidt, Assistant Attorney General

Jack Schwartz
Chief Counsel
Opinions & Advice