Make tough refinancings work with an FHA loan

House and dollar sign on teeter totter

You can refinance with an FHA loan even if you have little or no equity in your home, a damaged credit score or higher debt than lenders usually accept.

You may even be able to refinance with an FHA loan if you're currently unemployed. Try that with conventional financing.

The Federal Housing Administration (FHA), a division of the U.S. Department of Housing and Urban Development, doesn't actually make loans.

It guarantees that private lenders will be repaid even if you default.

Of course, you'll pay for that guarantee in the form of up-front and monthly mortgage insurance premiums.

But with the government standing behind you, banks and mortgage companies can make loans they wouldn't normally offer at competitive interest rates that could cut your monthly payments by hundreds of dollars.

You should know there are maximum loan limits for FHA loans. In 2016, you can borrow up to $271,050 for single-family homes in most places or up to $625,500 in high-cost cities like New York and San Francisco.

But your new loan may exceed these limits if it meets certain guidelines, especially if you're refinancing an existing FHA loan or you took out your original loan when the upper limits were higher.

Here are the 3 most common options for refinancing your home with the FHA's help.


Who is the typical FHA refinance applicant?

Attribute Purchase Refinance
FICO score 686 654
Equity in home 4% 21%
Debt-to-income ratio 42% 45%

Source: Ellie Mae Origination Insight Report, September 2016


Streamline refinancing

For borrowers who already have an FHA mortgage, regardless of how much home equity they have. An appraisal isn't required.

This isn't a foreclosure rescue program.

If you've had your loan for less than 12 months, you must have made all payments within the month due.

If you've had the loan longer, you must have no more than one 30-days-late payment in the last 12 months and have made all payments within the month due for the last three months.

Nor is streamline refinancing a way to get cash out of your home. Borrowing more than you need to pay off your existing loan is prohibited.

You can pay closing costs yourself or pay a slightly higher interest rate to a lender who pays the costs for you. You cannot have the loan origination charges, title insurance or other costs added to your loan.

The only cost you can add to your new loan is the up-front mortgage insurance premium.

If you're refinancing an FHA loan that you've had for less than 36 months, the FHA applies part of your original premium toward the new premium.

With a streamline refinance, since you already qualified when you took out your existing loan, the FHA doesn't require you to qualify again. There's no requirement for a credit check or income verification.

Lenders, however, may have stricter standards. If you know your only chance at qualifying is under the FHA's minimum requirements, ask lenders about a non-credit-qualifying streamline refinance.

Repeat customers are welcome in streamline refinancing, as long as 210 days have passed since your last closing date and you can save 5% or more on your monthly payment (after factoring in the annual mortgage insurance premium) by refinancing again.

With the FHA's half-point reduction in monthly mortgage insurance premiums, and mortgage rates that are lower than this time last year, it's worth finding out if you could benefit from refinancing.

To get started, call your lender and ask if you could qualify for a lower rate through this program.


Should you pay extra on your mortgage?

Paying off your home loan more quickly can save tens of thousands of dollars in interest charges. But before you start sending your spare cash to your lender, you need to make sure your overall finances are in order. Paying extra on your mortgage isn't always the smartest use of your money.


Rate-and-term refinancing

For borrowers who have a non-FHA loan and as little as 3.25% equity in their homes.

Conventional lenders want borrowers to have at least 20% equity to refinance. If you have 5% to 19.99%, you'll have to pay private mortgage insurance. With equity between 3.25% and 5%, the FHA is your best bet.

The FHA's rate-and-term refinance might also make sense if you have plenty of equity but your credit score has declined. Conventional lenders might turn you down or might charge higher interest rates. Just make sure you'll still come out ahead after factoring in the FHA's up-front and annual mortgage insurance.

"A borrower could refinance from a conventional loan to an FHA loan, but seldom would it be to their benefit," said California home loan consultant Greg Cook of the First Time Home Buyers Network.

If someone had to get out of their current loan because of a balloon payment or rate adjustment on an ARM, and they had only fair credit and not enough equity to refinance with a conventional loan, an FHA loan might be their only option, he says.

To obtain this financing, you'll have to qualify for an FHA mortgage much as you would if you were buying a home.

But you'll find many of the financial requirements are less stringent than those for a non-FHA loan.

Your credit score, for example, can be surprisingly low. As low as 500 as far as the FHA is concerned.

But lenders are allowed to set higher minimum standards — and they do.

FHA borrowers who refinanced in September 2016 had an average credit score of 654, according to Ellie Mae, a California-based mortgage technology firm whose software is used by many lenders.

That's significantly lower than the borrowers who refinanced a conventional loan; they had an average credit score of 747.


The 7 biggest mortgage mistakes

Dodging these pitfalls will make you a happier homebuyer now and more satisfied homeowner down the road. You'll know that you got the best possible mortgage and won't be overwhelmed by unexpected costs.



Besides poor credit, these things automatically disqualify you for an FHA loan:

To qualify for a rate-and-term refinance, you typically need a two-year history of steady employment, though there are exceptions. You might still qualify if you took time off work to raise kids, were unemployed for just a few months or were attending school.

You can also carry more debt. For most conventional refinances, borrowers must be spending no more than 43% of pretax income on all debts, including mortgage payments, student loans, credit cards and auto loans.

With an FHA mortgage, you can stretch that ratio up to 50% if your finances are strong in at least two "compensating factors."

Your two compensating factors might be savings in the bank equal to at least three total monthly mortgage payments and part-time or seasonal income that you've received for more than one year but less than two years.

If your credit score is below 580, however, the ratio can't exceed 43%.

Here again, lenders can impose tougher requirements than the FHA minimums. You're more likely to get approved if your debt-to-income ratio is less than 43%.

Most banks and mortgage companies offer FHA refinancing. Here's where to find FHA-approved lenders in your area.


The FHA short refinance program

For borrowers who don't have an FHA loan and owe more on their mortgages than their homes are worth.

This program reduces what you owe on your home to reflect its current value.

floatinghouse_refinance_sm

The government asks your current mortgage holder to reduce what you owe by at least 10% so that your new mortgage is no more than 97.75% of your home's current value.

If you have two mortgages on your home, you may be able to get the second loan eliminated. If not, the new loan's maximum loan-to-value can't exceed 115% of your home's current value.

The problem with this program is that you must be current on your payments to qualify, yet lenders are adamantly against writing down loans that are not delinquent.

That's why only 5,700 homeowners managed to complete an FHA short refinance between September 2010, when it began, and March 2015.

But if you'd like to take a shot, tell your current lender or any FHA-approved lender that you want to take advantage of the FHA's short refinance program. It runs through the end of 2016.