Conventional loan refinancing vs. FHA's `streamlined' version

MAILBAG

January 19, 2003

Dear Mr. Azrael:

I own a townhouse as an investment property with a Federal Housing Administration mortgage at 7.25 percent. The loan-to-value ratio is 60. I have been getting frequent solicitations regarding "streamline financing" to a lower rate.

The loan officer informs me that there are minimal costs involved in this type of refinancing and that the lending company will pay these costs in exchange for the business of reselling the loan on the secondary market.

Could there be hidden fees that I'm not being told about? How would this type of loan affect my principal? Overall, what do you think of this type of refinancing?

Jeff Swett Baltimore

Dear Mr. Swett:

Streamline refinancing for FHA-insured mortgages may offer borrowers an opportunity to reduce their loan interest rate and lower their monthly mortgage payment.

The streamline refinance program is limited to borrowers who have an existing FHA-insured loan, although some conventional lenders offer similar programs. The application and underwriting procedures are simplified.

There are no credit qualifications and no income qualifications. As a result, borrowers don't have to submit pay stubs, tax returns and other information to verify income or assets. The principal requirement is that the borrower have no late mortgage payments for 12 months preceding the refinance. In some cases, one late payment in the past 12 may be permitted.

Lender charges are limited under the FHA streamline program. Processing fees, appraisals, underwriting fees, loan documentation fees and other "add-on" type charges by lenders are prohibited. Lenders are permitted to charge a loan origination fee and a loan commitment fee. A loan "discount" fee also is permitted, but only if it reflects the actual cost of obtaining a below-market interest rate.

Under the FHA streamline program, the new loan amount cannot exceed the principal balance of the existing loan plus permitted lender charges and closing costs for title fees, interim interest, tax and insurance escrows and government recording fees.

In shopping for an FHA streamline loan, here are some tips from Kevin Kesecker, an officer of Atlantic Financial Inc., a mortgage lender based in College Park:

Loan origination fee - This is a fee or "point" (often 1 percent of the loan amount) that a lender may charge for originating the new FHA-insured loan. Some lenders offer a "zero point" loan with no origination fee. As an additional sales inducement, the lender may offer a broker credit to apply against closing costs. However, the annual interest rate on a zero-point loan usually will be 3/8 to 1/2 percent higher than a loan for which a 1 percent origination fee has been charged.

Since the lender is charging more than the minimum FHA interest rate, the origination fee and broker credit are built into the interest rate and are paid by the borrower in the form of a higher interest rate.

Commitment fees - Some lenders add on a $400 to $500 "commitment fee." In many cases, commitment fees are negotiable and you should not hesitate to negotiate or shop elsewhere if you feel that a fee should be reduced or waived.

An FHA streamline refinance, like any loan transaction, involves costs. All or most of the costs can be rolled into the new loan, so the borrower's out-of-pocket costs are minimal. But, the loan costs increase the principal of the new loan. Thus, the new loan will have a higher principal balance than the old loan and will take a longer time to pay off. The benefit is a lower monthly payment.

As a general rule, the reduction in your monthly payment should allow you to recoup the loan costs within two to three years. If you plan to sell your home before the loan costs are recovered, you will lose money on the refinancing.

With these tips in mind, let's answer Mr. Swett's specific questions. Costs of an FHA streamline loan usually are lower than other refinancing. The lender may pay an origination fee and the lender may give a credit against closing costs, but the new interest rate will be higher than if you paid the origination fee. All fees should be disclosed by the lender on a good-faith estimate given when you apply for the loan; there should be no hidden fees. The new loan will increase the principal of your loan if your closing costs and lender fees are rolled into the new loan.

In Mr. Swett's situation, a non-FHA (conventional) loan refinancing may be a better alternative. FHA-guaranteed loans generally carry a higher interest rate than comparable conventional loans because the borrower does not have a large equity in the property. Mr. Swett's current loan is only 60 percent of the market value of his property. Therefore, he doesn't need an FHA-insured loan. He probably can qualify for a conventional loan at a lower interest rate.

After investigating both FHA streamline and conventional refinancing, Mr. Swett can figure out how long it will take him to recover the loan costs through savings in monthly mortgage payments. A good mortgage broker or loan officer can assist in determining which type of refinancing will work best.

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