FHA loans make tough refinancings possible

Gray house on calculator

You can refinance with an FHA loan, even if you have little, or even no, equity in your home.

That can make all the difference in the world for borrowers who don't have at least 20% equity in their homes -- something banks and mortgage companies usually demand for conventional refinancings.

It's easier to qualify for an FHA loan, too. You can have lower credit scores and more debt than with a non-FHA mortgage.

The Federal Housing Administration, 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 the borrower defaults.

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.

There are three options for refinancing your home with this type of loan.

A Streamline Refinancing is for borrowers who already have an FHA loan, regardless of how much equity they have in their home. An appraisal isn't even required.

Since you've already qualified, you don't have to go through all the paperwork involved in qualifying again. That's why it's called a streamlined loan.

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

Standard Refinancing is for borrowers who have a non-FHA loan and as little as 2.25% equity in their homes.

(To calculate how much equity you have, subtract the balance on your mortgage from the home's current market value. Divide your equity by the home's value, multiply by 100, and you have the percentage of your equity.)

To obtain this financing, you'll have to qualify much like you would if you were buying a home.

But you'll find many of the financial requirements are less stringent than what you'd need to qualify for a non-FHA loan.

Your credit scores, for example, can be surprisingly low.

The government allows lenders to establish their own minimum credit score to qualify, and it's typically between 580 and 620. (Anything below 620 is considered a subprime score.)

Indeed, only two things can automatically disqualify you. If you've:

Beyond that, there's no strict set of rules for who qualifies and who doesn't. An underwriter at the bank analyzes your finances and makes the call.

To get a loan, you need two things: a two-year history of on-time bill payments and two years of steady employment. Even with these requirements, exceptions are made.

You can also be carrying more debt.

To obtain most non-FHA loans, borrowers must be spending no more than 36% of their pretax income on all debts, including mortgage payments, student loans, credit card bills and auto loans.

With an FHA loan, lenders will allow you to spend up to 41% of your pretax income on debt. Some lenders will stretch that to 43% for borrowers with an excellent payment history. (Use your own discretion on whether you should stretch your budget to spend that much of your pay on debt payments.)

You can apply for refinancing from most banks and mortgage companies. Here's where to find FHA-approved lenders in your area.

The Short Refinance Program is for borrowers who don't have an FHA loan and owe more on their mortgages than their homes are worth.

It's more than a simple refinancing. It's a way to reduce what you owe on your home to more closely reflect its current value.

When you apply, the government asks your current mortgage holder to reduce the amount you owe on your home by at least 10% so that your total mortgage debt, including first and second mortgages, is no more than 115% of the current value of your home (97.75% if you only have one mortgage).

The big problem with this program is that you must be current on your payments to qualify, and lenders are usually reluctant to write down the debt on loans that are not delinquent.

But it's still worth a try, since this is one of the few ways underwater homeowners (those who owe more than their homes are worth) can obtain a new loan.

To get the process started, tell your current lender that you want to take advantage of the Short Refinance program.

There are two more things you need to know about using an FHA loan to refinance your home.

First, you must be borrowing no more than $417,000 for a single-family home in most parts of the country, although you can qualify for as much as $729,750 in high-cost cities such as New York and San Francisco.

The big disadvantage to FHA refinancing is the mortgage insurance you have to pay up front. That's the price you pay for having the government stand behind your loan.

All borrowers, regardless of the term of their loan or the size of the down payment they make, must pay the 1% up-front Mortgage Insurance Premium at closing.

That means that you pay a $1,000 insurance premium on every $100,000.

While that can be added to your loan amount, it's still an extra charge.

Most borrowers will also have to pay monthly insurance premiums, which are comparable to what you would pay for private mortgage insurance on a non-FHA loan.

For a 30-year loan, with a down payment of less than 5%, your premiums will be 0.90% of the outstanding balance each year. If you put more than 5% down, your premiums will be 0.85%.

That cost is typically divided into 12 monthly payments and added to your mortgage payment.

You'll have to carry this insurance for at least five years and the balance on your loan is down to 78% of the original purchase price.

The private mortgage insurance required on non-FHA loans can usually be dropped after achieving 20% equity and making only one year's worth of payments.

Private mortgage insurance also allows you to count appreciation toward obtaining the needed equity. FHA loans do not.

For more information on all of these options, go to the Federal Housing Administration website.

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