- The Washington Times - Wednesday, March 15, 2006

We should continue last week’s discussion of the recent change in mortgage loans guaranteed by the Federal Housing Administration (FHA).

If you’ll recall, last October FHA increased its cash-out limits to 95 percent of the property’s value. While this change alone doesn’t necessarily constitute big news, it could be of interest to homeowners when we take it into consideration with today’s interesting market conditions.

In “normal” markets, when short-term rates are considerably lower than long-term rates, a homeowner seeking to cash out equity to 95 percent of the value might apply for a home equity line of credit (HELOC) through his bank.

The problem is that most HELOCs are tied to the prime rate, which has jumped from 4 percent to 7.50 percent in the last 19 months.

Furthermore, most lenders offering HELOCs allowing 95 percent financing will add a point or two to the prime rate, resulting in a variable interest rate between 8.50 and 9.50 percent.

Due to today’s unusual market conditions, where short-term rates are higher than long-term rates, FHA 30-year fixed loans are carrying rates considerably lower than the prime rate, making FHA cash-out refinancing a viable option.

There are some things to consider, however, before jumping on an FHA deal. First, FHA restricts its loan limits by county. The limit in the counties surrounding the Washington metropolitan area is $362,790, but it is reduced considerably in the rural areas.

Second, FHA requires that the borrower pay a Mortgage Insurance Premium (MIP) of 1.5 percent upfront and 0.5 percent per year to the monthly payment.

While these fees create a more expensive mortgage, other alternatives that allow 95 percent cash out are just as expensive.

Homeowners with an existing FHA loan are best suited for FHA cash-out refinancing because they are already paying the MIP. Let’s illustrate.

A homeowner currently has a 6.50 percent 30-year FHA loan in the amount of $280,000. His property has appreciated over the last five years and is now worth $350,000.

He wants to tap into his equity to 95 percent of the property’s value.

He first looks into an equity line and is quoted a rate of prime plus 1.50, which would equal 9 percent. The equity line would max out to $52,500. The principal and interest payment (P&I;) totals $422. The lender charges him $1,100 in closing costs.

The P&I; payment on his first trust, at 6.50 percent, is $1,770 per month. The monthly MIP is $108, making a total payment for both loans $2,300.

Alternatively, he runs the numbers under a 95 percent cash-out scenario with an FHA loan in the amount of $332,500. FHA requires that the upfront MIP of 1.50 percent be paid at settlement in cash or rolled into the loan amount. This fee, in addition to all the closing costs associated with refinancing, equates to an expensive refinancing.

However, thanks to the higher “coupons” available with FHA loans, the lender is able to pay a large portion of the closing costs in exchange for a higher interest rate. I see that with a 30-year fixed rate of 7 percent, the lender is able to contribute 2.50 percent toward the closing costs and MIP.

Let’s see how the numbers stack up.

The 1.50 percent MIP is equal to $4,987. Typical closing costs on a $332,500 refinancing might total $3,500. Total costs add up to a whopping $8,487.

But since the lender is kicking in 2.50 percent, or $8,312, he merely needs to come up with the difference of only $175.

Let’s look at the payments. The P&I; payment at 7 percent on a $332,500 loan is $2,212 per month. Add the 0.5 percent monthly MIP of $138, and we get a total of $2,350 — only $50 more than the combined loan package with the HELOC.

Considering that costs drop from $1,100 to $138 and that our homeowner isn’t exposed to future increases in the prime rate, an extra $50 a month certainly may be worth it.

For those readers carrying significant credit card debt: Has the minimum monthly payment recently increased? We’ll look at that in the next column as we continue to discuss the interesting current market.

Henry Savage is president of PMC Mortgage in Alexandria. Contact him by e-mail ([email protected]pmcmortgage.com).

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