Why it's harder to refinance a newer FHA loan

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You might have heard the Federal Housing Administration lowered its up-front mortgage insurance premium on FHA refinances for those whose existing loans closed before June 1, 2009.

You might also have heard the FHA increased both its up-front premium and its ongoing monthly mortgage insurance premiums for new loans.

What you probably haven’t heard is that many borrowers who took out loans on or after June 1, 2009, can’t refinance with today's low mortgage rates because the new premiums offset the interest rate savings.

The premiums borrowers pay on FHA loans are similar to the private mortgage insurance that low-down-payment borrowers pay on conventional loans.

Federal Housing Authority-backed loans require mortgage insurance because the typical borrower is a riskier bet than the typical conventional borrower.

Underwriting standards are more lenient than those for conventional loans. The mortgage insurance protects the lender if the borrower defaults.

"FHA loans were designed to help people at the margin -- those who could not quite qualify -- get a loan," says mortgage broker Todd Huettner of Denver-based Huettner Capital.

"The problem is that so many FHA loans are failing, and FHA keeps increasing the up-front and monthly mortgage insurance premiums to cover part of the loss," he says.

The result is very expensive mortgage insurance.

Monthly premiums in 2009 were just 0.55% of the loan balance per year, so many current borrowers pay that rate. Those eligible for the special program also will pay 0.55%.

But if you don't qualify, today’s premiums are as high as 1.25%, depending on what percentage of your home’s purchase price you’re borrowing.

The higher premiums mean many borrowers won’t save much, if anything, by refinancing.

Not only would you not want to refinance under these circumstances, the FHA might not let you.

FHA refinancing guidelines stipulate that there must be a "net tangible benefit" to borrowers from refinancing. The new principal, interest and monthly mortgage insurance payment must be at least 5% lower than the borrower’s current payment.

"If you got your current FHA loan after May 31, 2009, you will have to lower your rate about 2 (percentage points) or more to qualify for a refinance with current mortgage insurance costs," says Huettner.

Instead of paying an up-front premium of 0.1% of the $200,000 borrowed, or a measly $200, you'd pay 1.75%, or $3,500.

Refinancing a loan that closed May 31, 2009, would mean an annual mortgage insurance premium of 0.55%; a loan that closed on June 1, 2009, would have premiums as high as 1.25%.

On a $200,000 loan, that’s $1,100 versus $2,500, a $1,400 difference each year for as long as you’re required to pay mortgage insurance.

And you have to pay for a minimum of five years or until your reach 80% loan-to-value, whichever comes later.

For the borrower who puts down the minimum, it takes about 10 years to reach 80% loan-to-value. So the higher premium costs about $14,000 in the long run.

For those who can take advantage of the lower premiums, it could save you a bundle.

The Department of Housing and Urban Development "estimates that the average borrower will save approximately $250 monthly by refinancing to current market rates," says Matt Kovach, a product development manager for Envoy Mortgage in Houston. And the FHA’s streamline program allows even borrowers who are upside down to get a new loan.

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