Mortgage Q & A: Is an FHA refinance an option?

Q: I'd like to refinance my home and am wondering if an FHA refinance could be an option. You see, when I found a new job after being unemployed, I tried to refinance my mortgage through the same company that gave me my original loan. However, they told me that my debt-to-income ratio was too high (I used my credit cards to get through part of the unemployment phase). The loan officer also said that my home had lost value and that I didn't have enough equity to refinance with a conventional mortgage. I am prepared to pay for closing costs, but can't pay the existing mortgage down in order to refinance with a conventional loan. Would looking into an FHA refinance be an option?

A: Yes; you do have the option of refinancing from a conventional mortgage to an FHA-insured mortgage, but FHA might not be your best option. Changes to the program (including a requirement that you pay mortgage insurance for the entire life of the loan) make FHA loans more costly than they used to be. Here are two alternatives that might be better.

HARP Refinance Cheaper than FHA

If your current mortgage is backed or owned by Fannie Mae or Freddie Mac, you may qualify through the HARP refinance program. Both enterprises have look-up pages online that let you see if your loan is with them. Your income and home value are not obstacles if you are eligible. Not all lenders participate, but if your lender doesn't wish to refinance you, there are others that might -- check LendingTree for competitive offers. The HARP refinance program was created so that people with little equity, no equity or even negative equity can refinance to better mortgage rates. If you're paying for mortgage insurance, your premiums stay the same, and if you don't have mortgage insurance you won't be required to get it.

Community Mortgages Offer Low Costs and Flexible Underwriting

Another option that might work for you if you qualify (there are income eligibility guidelines) is a My Community Mortgage from Fannie Mae or a Home Possible mortgage from Freddie Mac. These community mortgage programs are limited to people who meet income limitations (100 percent of the median income in their area). Mortgage insurance is required, but premiums are considerably lower than those of standard programs or FHA home loans. Underwriting guidelines are less rigorous, and the maximum debt-to-income ratio is 45 percent, which is higher than FHA's. Community mortgages have maximum loan-to-value ratios of 95 percent, but Fannie Mae just announced that it will soon be offering a 97 percent mortgage.

FHA Guidelines

If FHA is your only option and can save you money, go ahead and apply. FHA mortgage lenders evaluate several factors, including your debt-to-income ratio and your credit score. While the official minimum credit score is 580 for a 96.5 percent refinance, many FHA lenders look for credit scores of 620 or better. Lenders will also verify your income and employment status.

The maximum debt-to-income ratio for an FHA loan is 43 percent. This is calculated by adding your total housing expense -- principal, interest, taxes, insurance (and HOA dues if applicable) to your other monthly accounts (car loans, credit card payments, student loans, etc., but not living expenses like utilities), and then dividing by your gross (before tax) income.

As a start, you may want to request several FHA mortgage quotes. FHA-approved lenders should be able to work with you given your specific needs and circumstances, but be aware that lender requirements can vary. The FHA allows its lenders to add their own loan approval requirements in addition to those already established by the FHA. Sometimes, FHA lenders have their own --even stricter-- approval guidelines while others strictly stick to those established by the FHA.

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