Why aren’t more people refinancing existing FHA loans?
I read a recent story on nationalmortgagenews.com written by Brian Collins that speaks about the lack of existing FHA mortgagors refinancing into today’s current low interest rates. His article states that at this time last year mortgage interest rates were a little lower than they are today, but mortgage refinance applications were at approximately 150,000. Today the number of applications sits at about 50,000. You may be thinking that the reason why applications have fallen is because values have fallen and it’s made refinancing impossible for existing FHA mortgages. The fact is that if you have a FHA loan and are refinancing into another FHA, this is called a FHA Streamlined Refinance, then the appraisal condition is waived, meaning that the borrower doesn’t need an appraisal to get the loan. FHA Streamline loans are much easier to qualify for as a result of not needing an appraisal, the only real hurdle is that you must have maintained on time payments and have an appropriate income to keep your debt to income ratios in line.
I believe that I know the exact reason why people aren’t refinancing existing FHA loans into new FHA loans and that reason is because HUD is purposely making it more expensive to do so. I wrote about the different types of mortgage insurance in this article which is where the heart of my argument begins. FHA has a monthly mortgage insurance payment and a onetime upfront mortgage insurance premium that must be paid by the mortgagor. The simple explanation for the reason these mortgage insurance premiums are in place is because FHA loans carry more risk for the individual investors and this risk must be minimized and spread out over the borrower’s. The mortgage insurance premiums are based on mathematical calculations, the upfront mortgage insurance premium(UFMIP) is 1% of the loan amount, and the monthly mortgage insurance premium (MIP) varies based on loan term and loan to value, but it’s usually 1.15% annually. What does this have to do with the reasons for why people aren’t taking advantage of FHA Streamlined refi’s? One year ago the UFMIP was 1.25% and the MIP was .55% annually. How does this change in MIP affect the borrower? Let’s look at one of my client’s loans and you’ll see why it’s more difficult to refi FHA loans.
Mr. Jones refi’d last year with a loan amount of $625,500. Below is the breakdown of his payment
Principle and Interest payment= $3502/mo.
Monthly mortgage insurance= $286.69 for a total monthly payment of $3788.69 not including taxes and hazard insurance.
Mr. Jones now owes $616,000 one year later, but after closing costs, daily interest, new UFMIP, etc. the loan amount is $626,000. You’d think that a full 1.25% drop in rate on a large loan amount would produce huge savings, right? Let’s look at it.
New Principle and Interest payment= $3,033.91/mo.(a straight savings of $468/mo.)
Monthly mortgage insurance= $590 for a total monthly payment of $3,623.91 and a savings over the previous payment of $164.78/mo.
The borrower drops the rate by 1.25% and the savings only equates to $165/mo., this is a direct result of the increased MIP. Is it worth it for you to refinance if you only save $165? You may look at this and say, “165 bucks per month is good enough for me, I’d enjoy saving that monthly.” Here’s the problem, FHA rules state that the borrower must have a net savings of 5% over the previous monthly payment to even do the loan. In order for this borrower to meet the 5% net tangible benefit test the payment would need to drop $189/mo. and therefore this borrower does not qualify.
So why does HUD make it so difficult to refinance if it’s in the borrower’s best interest to do so? One of the last statements in the article made it clear, “the Department of Housing and Urban Development and FHA are constrained from encouraging borrowers to refinance because most of the loans are pooled into Ginnie Mae MBS. Encouraging faster repays would diminish the value of the MBS and negatively affect investors, HUD says.” Follow the money and the question is answered. Investors earn less money when loans are paid off early, and if you lose investors, or buyer’s of your product, then it’s no longer profitable to offer the product. If nobody buys FHA mortgage bonds then the cost of FHA loans would increase dramatically, and ultimately less people would be able to benefit from the loan program. Is it a bad thing that these restrictions are put in place or are they in place to assure that the FHA product will be around for new borrowers?