In my last column , I discussed the details of the relatively new change in mortgage loans guaranteed by the Federal Housing Administration (FHA). Last October, FHA increased their cash out limits to 95 percent of the property's value. While this change alone doesn't necessarily constitute big news, it could be of interest to homeowners when we take it into consideration with today's interesting market conditions.
While FHA loans have generally been out of favor for several years due to more favorable conventional programs on the market, the change to allow 95 percent cash out may mark a spur in demand.
For folks who want to cash out to 95 percent, they might find that an FHA loan is the best deal. Consider the following:
- Home Equity Lines of Credit (HELOCs) are usually tied to the prime rate, which is now at 7.75 percent. Most lenders that offer a HELOC to 95 percent will add at least one percent to the prime rate. 8.75 percent isn't such a great rate.
- While fixed rate mortgages are actually about one percent lower than the prime rate, finding a 95 percent cash out deal is going to be tough. Even if there's one available, it's going to be expensive.
Let's take a look at a real life scenario.
George currently has a 6.50 percent 30 year FHA loan in the amount of $230,000. His property has appreciated over the last five years and is now worth $375,000. He wants to tap into his equity to 95 percent of the property's value.
He first looks into an equity line and is quoted a rate of prime + 1.50, which would equal 9.25 percent. The equity line would max out to $126,250. The principal and interest payment (P&I) totals $1,038. The lender charges him $1,100 in closing costs.
The P&I payment on his first trust, at 6.50 percent, is $1,525 per month. The monthly Mortgage Insurance Premium (required on FHA loans) is $96, making a total payment for both loans $2,659.
Alternatively, he runs the numbers under a 95 percent cash out scenario with a new FHA loan in the amount of $356,250. FHA requires that the up front MIP of 1.50 percent be paid at settlement in cash or rolled into the loan amount. This fee, in addition to all the closing costs associated with a refinance, equates to an expensive refinance.
But thanks to the higher "coupons" available with FHA loans, the lender is able to pay a large portion of the closing costs in exchange for a higher interest rate. I see that with a 30 year fixed rate of 7.00 percent, the lender is able to contribute 2.5 percent towards the closing costs and MIP. Let's see how the numbers stack up.
The 1.50 percent MIP is equal to $5,344. Typical closing costs on a $356,250 refinance might total $3,800. Total costs add up to a whopping $9,144. But since the lender is kicking in 2.50 percent, or $8,906, he merely needs to come up with the difference of only $238.
Let's look at the payments. The P&I payment at 7.00 percent on a $356,250 loan is $2,370 per month. Add the .5 percent monthly MIP of $148 and we get a total of $2,518 -- $141 less than the combined loan package with the HELOC.
Here's the bottom line for George: Costs drop from $1,100 to $238, the total payment is $141 less, and he isn't exposed to future increases in the prime rate.
In certain situations, an FHA cash out refi may indeed beat out the competition.
