New Standards For FHA Refinancing

by Peter G. Miller
September 8th, 2010

Starting Monday HUD has new standards for borrowers who want to replace two loans with a single FHA mortgage.

The old rule worked like this: Since 2007 the FHA has said borrowers could refinance a conventional first loan regardless of the amount of any second lien.

“If the new maximum FHA loan is not enough to pay off the existing first lien, closing costs and arrearages,” said HUD, “the lender may execute a second lien at closing to pay the difference. The combined amount of the FHASecure first mortgage and any subordinate non-FHA insured lien may exceed the applicable FHA loan-to-value ratio and geographical maximum mortgage amount. If payments on the second are required, they must be included in qualifying the borrower. If payments are deferred, they must be so for no less than 36 months to not be considered in the qualifying ratios.”

Now HUD is going in the other direction and dumping the unlimited combined loan-to-value (CLTV) when a property has two loans.

In a program which went into effect Monday, HUD explains that with the exception of streamline refinance transactions, the combined amount of the FHA-insured first mortgage and any subordinate lien may not exceed the applicable FHA loan-to-value ratio AND the geographical maximum mortgage amount.

Maximum CLTV for Refinance Transactions

The new standards look like this:

___ Rate and Term (or No Cash Out) Refinances — 97.75%

___ Refinances for Borrowers in Negative Equity Positions — 115% (This refinance option is only available through December 31, 2012.)

___ FHA-to-FHA Streamline Refinances With or Without Appraisals — 125%

___ Cash-out Refinances — 85%

New Realities

Essentially HUD is going to a more conservative refinancing standard. This makes sense given marketplace realities because it will mean less risk for the FHA, which is, after all, an insurance program.

However, the usual conflict will also arise from this situation: A more conservative standard will mean some borrowers will no longer qualify for an FHA loan refinance.

Is this a fair trade-off?

Well sure, yes. For the FHA to be successful it must be solvent. This means it can’t offer mortgage insurance to everyone. There are various limits, including those related to credit scores, loan amounts and seller contributions. A new CTLV is simply another limit, one which existed prior to 2007.

Moreover, it should be said that if the FHA is missing a business opportunity of some sort then mortgage insurance companies in the private sector might rush to fill in the gap.

But private mortgage insurance companies also want to remain solvent. They’re generally conservative, which is appropriate for the product and service they offer.

In the end the new FHA CLTV standard is simply another reasonable, rational effort to contain risk, something seen throughout the lending arena. No one wants to go back to the “old days” of unlimited risk justified somehow by the thought that home prices always rise.

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