- The Washington Times - Friday, August 3, 2007

I want to describe a refinance my company recently made for a customer in South Carolina.

The homeowner carried a 30-year fixed-rate loan in the amount of $80,000 at 7.25 percent. The property appraised at $110,000. Due to some unforeseen circumstances, my customer had racked up about $20,000 in credit card debt. The monthly payments simply were not manageable.

He called me and asked about an equity line or a consolidation loan.

I pulled his credit report and found that his credit score is 660, which is considered to be only fair. I then did a little research and presented him with my conclusions.

Here they are:

1) Keep the existing mortgage in place and obtain a home equity line of credit or a fixed-rate second trust to pay off the credit card debt.

There are some inherent problems with this option. First, most second-trust loans will only allow you to borrow 90 percent of the property’s appraised value. ($110,000 times 90 percent equals $99,000.) After subtracting the $80,000 existing mortgage, my client ends up with only $19,000, minus any charges. This is not enough money to pay off all his consumer debt.

A bigger problem exists with his credit score. Most second-trust lenders will require a higher score, eliminating him as a candidate for these programs.

2) Refinance his existing first trust to a larger loan and use the excess cash to pay off the credit cards.

We have the same problems. Fannie Mae and the Federal Home Loan Mortgage Corp. (Freddie Mac), the two giant corporations that buy mortgages from lenders, also limit their cash-out refinances to 90 percent. Additionally, his credit score is too low to obtain an approval.

3) I turn to a fixed-rate loan program guaranteed by the Federal Housing Administration. FHA loans once were popular, but the emergence of a wider variety of conventional loans largely made FHA loans uncompetitive. It appears FHA loans may be coming back into favor. Here’s why:

First, FHA will allow a cash-out refinance to 95 percent of the property’s value. This would allow my client to obtain a loan for $104,500.

Second, FHA will accept borrowers with lower scores than Freddie Mac and Fannie Mae. When we submitted the loan package to underwriting, the loan was approved.

So I recommend that an FHA loan best suits my borrower’s objectives: to consolidate high-interest consumer debt into low-interest, tax-deductible mortgage debt that will result in significant cash flow savings.

What’s the downside? FHA loans can be expensive. In addition to typical closing costs, in most cases, FHA charges a 1.50 percent mortgage insurance premium (MIP). While these charges can be rolled into the loan amount, they are, indeed, “sunken costs.” In addition to the upfront MIP, FHA tacks on a half-percent annual fee, which is added to the monthly payment.

The bottom line for my client was still favorable, especially since other eligible alternatives required him to search the subprime market, where the fees and rates are far higher than any FHA loan.

The numbers turned out like this. He reduced his interest rate to 6.75 percent. He paid off all his consumer debt. His sunken costs amounted to about $3,500, but he still ended up receiving about $1,000 cash at settlement after the debts were paid. The most important result of the transaction was that the borrower walked away with almost $800 in monthly cash flow relief. This extra cash flow should prevent him from jacking up the credit cards again.

One caveat: FHA’s loan limits are too low in many high-value areas. Raising these limits is being reviewed by Congress.

While this program may not be the best available that someone with perfect credit would consider, it’s a great alternative for folks who only qualify for expensive subprime programs.

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

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