- The Washington Times - Friday, December 4, 2009

Q. I purchased a property 18 months ago and took out a loan backed by the

Federal Housing Administration (FHA). I have a 6.75 percent fixed rate, but I understand rates are a lot lower now.

The loan officer at my bank suggested that I refinance to a new FHA loan, but my financial adviser tells me the costs are too high to justify the drop in rate. Sure enough, the good-faith estimate had a low rate of 4.75 percent, but my loan balance shot up from $280,000 to $295,000.

The loan officer told me that over time, I will save money with the lower interest rate. He also says the FHA Mortgage Insurance Premium (MIP) won’t be expensive because I will receive a refund from FHA.

I hear about people refinancing their FHA loans all the time. What am I missing? It doesn’t seem like a very good deal to me.

A. Your financial adviser is correct. It appears that the loan officer is trying to sell you an expensive loan with a very low interest rate. It’s not a good strategy. However, remaining at 6.75 percent doesn’t make sense, either. You have given me enough information that I probably can dissect the situation with some accuracy.

With a rate of 4.75 percent, your loan officer probably is charging two points. Because one point is equal to 1 percent of the loan amount, you would pay about $5,600 in points from the start. You might pay an additional $3,000 in transactional closing costs for things such as an appraisal, title insurance, county recording fees, etc. That’s up to $8,600 in sunken costs.

Let’s talk about the MIP. FHA is a self-funded government program, meaning taxpayers do not foot the bill. Anyone seeking an FHA loan must pay the MIP, which is pooled together and used to offset any FHA loans that may go into default. The MIP is typically 1.75 percent of the loan amount. It is usually rolled into the loan amount, which means the borrower’s loan balance increases, but he or she doesn’t have to pay for it with cash.

If an FHA loan is refinanced to another FHA loan, the borrower is entitled to a refund of the initial MIP. The amount of the refund depends upon how old the original loan is. The older the original loan, the less the refund. After three years, the refund drops to zero.

I see from my MIP refund chart that you are entitled to a 46 percent refund of your MIP because your loan is 18 months old. This would be applied to the new MIP on the new FHA loan. I am guessing that the original MIP was somewhere near $5,000. If you refinance, you would be entitled to a $2,300 refund.

Your new MIP might be somewhere in the range of $5,000. Applying the refund would make the new MIP cost $2,700. We are now looking at total refinance costs around $11,300. If we roll in prepaid interest and escrow deposits for taxes and hazard insurance, it makes perfect sense that your loan balance would need to increase by $15,000.

Escrow deposits and prepaid interest are not considered a cost because they are items that must be paid regardless of whether you refinance. Other items, such as points, lender fees, settlement fees and the MIP, are indeed transactional costs. It appears your loan officer wants you to spend more than $11,000 to refinance.

Abandon this idea. As of this writing, you should be able to find an FHA loan with a rate at about 5.25 percent with no points or closing costs. The only cost associated with the refinance would be the difference between the new MIP and the refund of the old MIP. I’m guessing it will come in right around $2,700. Though the interest rate of 5.25 percent isn’t as low as 4.75 percent, it’s still a lot lower than 6.75 percent. You will save $8,600 in fees and points.

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

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