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Mortgage Q&A: Refinancing FHA loans can be tricky

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While mortgage rates continue to stay down, I think it's appropriate for an update aimed at homeowners with loans insured by the Federal Housing Administration (FHA).

FHA rates are incredibly low, and a refinance might make sense for many homeowners with FHA-backed loans. But because FHA loans, in my opinion, are needlessly complicated, the interest rate you receive depends upon your particular circumstances. Let me explain.

FHA has two charges: an annual mortgage insurance premium (MIP) that's part of the monthly mortgage payment and an upfront mortgage insurance premium (UFMIP) that must be paid at the time of settlement. For those seeking to refinance an existing FHA loan, the amount of the charges depends upon the age of the loan to be refinanced.

If the borrower is seeking to refinance an FHA loan that was endorsed by the FHA after May 31, 2009, the annual MIP is 1.25 percent, paid monthly. The UFMIP is 1.75 percent. This is bad news because these premiums recently were increased.

Homeowners seeking to refinance to a lower interest rate certainly may do so, and a lower rate will reduce the principal-and-interest portion of the monthly payment. But the monthly MIP is likely to rise, which will somewhat -- or possibly entirely -- offset the benefit of a lower interest rate, making the refinance impractical. Additionally, a 1.75 percent upfront fee is a hefty price, whether it's paid out of pocket or added to the loan amount.

For those who have an FHA loan that was endorsed on or before May 31, 2009, the news is great if the borrower qualifies for a streamline refinance. The new annual MIP for those loans is reduced to just .55 percent, and the UFMIP drops to an insignificant .01 percent.

While homeowners with older FHA loans have the advantage when it comes to refinancing, those who have newer FHA loans still should see whether a refi makes sense. Rates are so low that some lenders are offering such high closing-cost credits that the high UFMIP effectively can be rolled into the new interest rate. Here are two examples.

I have two FHA loans, each with a balance of $250,000. The first loan was endorsed by the FHA before May 31, 2009, and the second one was endorsed after that date. The older loan can be refinanced with an annual MIP of $1,375, or $115 per month. The UFMIP on the refinanced older loan is just $25.

The borrower refinancing the newer loan gets gouged. His MIP is 1.25 percent, or $260 per month. His UFMIP is a whopping 1.75 percent, or $4,375.

As I said, all FHA loan holders still should check to see if refinancing makes sense because some lenders offer credits that will cover the UFMIP plus all the closing costs.

In this example and as of this writing, I would offer a fixed rate of 3.25 percent to the borrower refinancing the newer loan, because his lender credit will total about $7,000, enough to cover all the closing costs and the UFMIP of $4,375. The borrower refinancing the older loan received a rate of 2.875 percent, with a closing-cost credit of about $3,000. This is enough to cover his total costs.

FHA borrowers: A competent loan officer should be able to dissect your particular situation and determine whether an FHA refi makes sense.

Henry Savage is president of PMC Mortgage in Alexandria. Send email to henrysavage@pmcmortgage.com.

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