- The Washington Times - Wednesday, March 8, 2006

Last October, mortgage loans guaranteed by the Federal Housing Administration

(FHA) increased their cash-out loan limits for refinances to 95 percent of the property’s value. This change, coupled with the current unusual interest rate environment, may be of interest to thousands of homeowners.

The Federal Housing Administration was created by Congress in 1934. For most of the latter half of the 20th century, loans guaranteed by FHA were the optimal choice for first-time home buyers, due to a low down payment requirement and less stringent income and credit qualifications.

During the last decade or so, the product line offered through conventional mortgage financing exploded, thanks to the growth of the secondary mortgage market, which packages loans and sells them as securities to investors. In many geographic markets, FHA loans are often no longer the best choice for first-time home buyers.

With the new 95 percent cash-out loan limit, I predict a substantial increase in FHA refinance activity in 2006 and 2007.

Why would I make such a bold prediction in a market where interest rates have risen considerably and are poised to rise higher? A recent series of events leads me to make such a statement. Let’s take a look.

First, property values across the nation have increased substantially and, in some areas, skyrocketed. Since 2001, homeowners have been eager to cash in on their newfound equity by increasing their mortgage debt.

Second, the most popular methods of tapping into home equity are passing out of favor. Home equity lines of credit (HELOCs) are usually tied to the prime rate. Only a year and a half ago, the prime was sitting at 4 percent. Today, thanks to the Federal Reserve’s rate hikes, the prime is now at 7.50 percent.

Long-term mortgage rates have risen as well, albeit not as dramatically as short-term rates. Still, the overall rise in interest rates has curtailed the demand for cash-out refinances and HELOCs.

If rates have risen across the board, why am I predicting an increase in FHA refinances? The key is loan-to-value. There aren’t a whole lot of better alternatives if a homeowner is seeking 95 percent financing. Let’s take a closer look.

A HELOC allowing a loan-to-value (LTV) of 95 percent will carry a rate considerably higher than the prime rate. Expect the rate to be somewhere between 1 or 2 percent over prime. That’s between 8.50 and 9.50 percent — hardly a bargain compared to recent history. Moreover, these rates will move as the prime rate moves, which is predicted to continue to edge up.

Refinancing with cash out to a 30-year fixed-rate is fine and dandy as long as you keep the LTV below 80 percent. A 95 percent cash-out fixed-rate is going to be hard to find and very expensive.

To make this deal even less attractive, the lender will require that the borrower pay private mortgage insurance (PMI) because the LTV exceeds 80 percent. Expect to pay somewhere near 1 percent for PMI, on top of the jacked up mortgage rate.

The terms of a 95 percent FHA cash-out refinance aren’t the greatest, but the program is very likely the best option when considering the other alternatives. Consider the following:

• Unlike conventional loans, most lenders and brokers do not increase the rate or charge extra fees for a 95 percent FHA cash-out refinance.

m FHA offers 30-year fixed-rates to 95 percent, making such a deal more favorable than the adjustable, prime-based HELOCs.

m FHA programs allow for higher “coupons,” meaning a borrower can choose to take a higher rate and have some or all of the closing costs eliminated.

The downside of taking an FHA loan is the government-mandated Mortgage Insurance Premium, or MIP. MIP is largely the reason FHA loans have not been able to compete with conventional alternatives during the last decade.

However, FHA’s decision to increase their LTV to 95 percent suddenly makes it a viable product that needs to be considered.

Each situation needs to be evaluated carefully by a competent loan officer.

In future columns, I will outline in some detail a couple of examples where FHA cash-out refinancing would be the best alternative. I will also go into some detail as to the biggest reason I’m predicting an increase in demand for this product: the recent decision by banks to increase the minimum monthly payment on credit cards.

Henry Savage is president of PMC Mortgage in Alexandria. Contact him by e-mail (henrysavage@pmcmortgage.com).

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