I have heard more and more clients tell me that some nameless, faceless mortgage people or “friends” have told them they should refinance from a Conventional loan to an FHA loan. Huh? Usually the smart advice giver is giving the advice because they know the client has had a hard time getting a sufficient appraisal to refinance as a Conventional loan, and that FHA requires much less equity.
Wow, I am surprised that such incredibly expensive advice is still being passed out.
Why this is a silly idea
Here is why I find that advice silly, and if you have a friend who is refinancing off of a Conventional loan with no PMI and onto an FHA loan you need to beg him/her to NOT do that.
The maximum FHA loan is $729,000 in a high cost area. Let’s assume you owe around that amount.
All FHA loans, regardless of LTV and equity position, have mortgage insurance. The up front FHA MIP (Mortgage Insurance Premium) is currently 1.75% and is scheduled to go to 2.25%. The latest FHA rule changes were passed weeks ago, so I am unsure when new FHA loans will be subjected to the increase. Let’s assume we could sneak you in at the 1.75%, that is $12,757 in mortgage insurance premium. You can either pay that out of pocket or finance it into the loan, 99% of FHA loans finance it into the loan, which effectively raises the cost over time since you’ll be paying interest on it. That interest is about $70/month at today’s rates.
There is also monthly FHA mortgage insurance, which is .55% of the loan divided by 12 (this is also schedule to rise slightly). This would be $334/month.
So you have already paid an increase of $404 a month for the FHA mortgage insurance plan.
And you have artificially raised your loan amount by $12,757 to finance in the FHA MIP. This is on top of approximately $4,000 in title and lender closing costs.
The ultimate total cost to refi the loan is enormous:
$12,757 in up front PMI
$4,000 in closing costs
$404 a month in extra payments, $4,800 annually, $24,000 over 5 years, etc.
I have people who complain down to a few hundred dollars when I quote them $4,000 in costs to the title company, lender and appraiser, why you’d spend the enormous sums above I am not sure. A refi is supposed to be about saving money, not spending it.
I know some people are in an utter state of panic over the future, and I am concerned to a degree. But for banks and lenders to take advantage of people’s fear and sell them an expensive FHA loan is negligent.
Who is an FHA loan for?
An FHA loan is for someone who is low-moderately qualified, with weaker credit scores, and little assets. I know people use this loan for purposes it was not intended, but I feel this is a BIG stretch if you are well qualified, and it is too expensive if you currently have a Conventional loan.
And no matter what your loan amount, even if you owe much less than the $729,250 maximum FHA loan amount, when you take 1.75% to 2.25% of it for the up front Mortgage Insurance Premium, and then you take .55% and divide by 12 for the monthly mortgage insurance payments, it creates way too much cost to make a refinance make sense.
Does FHA to FHA refi make sense?
If you currently have an FHA loan then this is a different story. An FHA-to-FHA refinance can be done more cheaply, might be able to be done as a “streamline refinance”, and the homeowners is already paying mortgage insurance so there is no adjustment.