FHA refinancing now could be out of reach for some

Photo: MGShelton

When you take out an FHA mortgage, you have to pay a lot of mortgage insurance.

Today’s mortgage insurance premiums (MIPs) are as high as 1.25% depending on what percentage of your home’s purchase price you’re borrowing (called “loan to value” or LTV, in mortgage industry-speak). They used to be just 0.55%.

Today's MIP rates are tiered and get as low as 0.35% if you have a 15-year mortgage and a loan-to-value below 90%. But FHA borrowers tend to put down as little as possible and want the smallest monthly payment possible, which often means 3.5% down (or 96.5% LTV) on a 30-year mortgage.

Today's higher MIPs mean many borrowers won’t save much, if anything, by refinancing.

Plus, refinancing means closing costs, which typically amount to thousands of dollars.

Even if you wanted to refinance your FHA loan under these less-than-ideal circumstances, FHA refinancing guidelines stipulate that there must be a “net tangible benefit” to borrowers from refinancing. The new principal, interest and monthly mortgage insurance payment must be at least 5% lower than the borrower’s current payment.  

“Benefit to borrower rules were put in place to make sure there was a savings or other benefit to someone refinancing,”  and not just a benefit to the lender facilitating the transaction, says mortgage broker Todd Huettner of Denver-based Huettner Capital.

If your loan closed on May 31, 2009, the cutoff date for a discounted FHA refinancing program, your refinancing math will probably look dramatically better than if your loan closed on  June 1, 2009. The UFMIP cost changes from a couple hundred dollars to several thousand.

And the real cost of UFMIPs is often higher because borrowers typically roll the premium into their mortgage and pay interest on it for the life of the loan. 

The difference in monthly MIPs also amounts to thousands over the life of the loan.

The loan cutoff date to refinance under the more favorable terms seems arbitrary. The Department of Housing and Urban Development, which sets FHA guidelines, has attempted to justify its decision by stating that borrowers who took out loans prior to June 1, 2009, typically have interest rates of at least 5% and stand to gain the most by refinancing.

Matt Kovach, a product development manager in Houston, Texas, for Envoy Mortgage, says the FHA lowered both the up-front and annual premiums to spur these homeowners to refinance and ultimately reduce the risk of future defaults on these loans.

Since FHA loans are government guaranteed, taxpayers like you and I must cover the losses when a homeowner defaults on his FHA loan.

Huettner points out that any time a borrower is able to lower her interest rate by refinancing, the odds that he or she will default get lower.

The FHA’s streamline program doesn’t allow cash-out refinancing, nor does it allow borrowers to roll closing costs into the mortgage. In other words, the amount borrowed can’t increase. There’s really no way to increase that borrower’s default risk by allowing a refinance.

But why should special terms only be available to the borrowers who stand to benefit the most? It seems like it would make sense to offer the more generous streamline refinance pricing to all FHA borrowers, not just a limited pool.

Get more details in my Interest.com article, Why it's harder to refinance a newer FHA loan.