- The Washington Times - Wednesday, March 22, 2006

We have been discussing the change in mortgage loans guaranteed by the Federal Housing Administration (FHA). Specifically, FHA has increased its cash-out limits for refinancing to 95 percent of the home’s value.

While this might not have a significant impact on homeowners under normal circumstances, I am predicting an increase in FHA refinance activity largely due to the unusual interest rate environment.

Historically, a more common method of tapping into equity was to take out a home equity line of credit. These programs are widely advertised by banks and usually tied to the prime rate. The problem is that the prime rate has moved from 4 percent to 7.50 percent in the last 19 months. Such a sharp increase in rate is certain to curtail demand for the product.

At the same time, fixed rates on FHA loans are hovering around 6.50 percent. For those seeking to cash out up to 95 percent, FHA cash-out refinancing might be a better alternative.

There is another change currently in the works that might stimulate demand for FHA cash-out refinancing even more. For homeowners carrying significant credit card debt, it’s possible that the minimum payment could double very soon, if it hasn’t already.

Under pressure from federal banking regulators, credit card companies are raising the minimum payment to include more principal curtailment. In the long run, higher payments will save the credit card holder thousands in interest cost, but the higher payment could have a stinging effect on monthly cash flow.

Many credit card companies have already raised minimum payments from 2 percent to 4 percent. This increases the payment on a $20,000 balance from $400 to $800. The change is particularly ill-timed, as short-term interest rates are on the rise and predicted to rise more.

Might these credit-card-debt-ridden folks turn to FHA refinancing to avoid the payment sting? It’s hard to tell, but the move certainly would improve cash flow. Using a 30-year fixed rate of 6.75 percent, financing an extra $20,000 in a mortgage in order to eliminate the credit card debt will increase the mortgage payment by only $130. This is a $670 cash flow improvement when compared to paying a minimum 4 percent to the credit card company.

There are some other clear advantages. The interest rate on credit cards could exceed 18 percent, while an FHA fixed-rate would be between 6 and 7 percent. Plus, mortgage interest is tax deductible while interest on consumer debt is not.

Not all homeowners are eligible for FHA loans. The maximum FHA loan allowed varies by county. Additionally, it may not make sense to pay off an existing mortgage with favorable terms and convert it to an FHA loan with less favorable terms only for the purpose of eliminating credit card debt.

Folks best suited for 95 percent cash-out refinancing are those who currently carry an FHA loan and have considerable credit card debt. A good loan officer can dissect the individual situation and determine if such a move is advantageous.

One very important caveat: Converting high-interest credit card debt to low-interest, tax deductible mortgage debt will save thousands, but doing so requires the discipline to pay off any future credit card balances in full every month. The last thing you would want to do is eat up your home’s equity just to bring your credit card balances to zero so you can jack them up again. Doing so would be very unwise.

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

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