Using FHA To Refinance When You Have Very Little Equity

February 25, 2017 - 6 min read

The FHA Refinance Almost No One Knows About

When people hear FHA, they typically think of a low-downpayment mortgage for first-time home buyers, which it is.

But this loan also offers refinance help for near-underwater homeowners, even those who don’t have an currently.

Another loan type, the Home Affordable Refinance Program, or HARP, offers refinance loans to homeowners with little or no equity. But the current loan must be owned by Fannie Mae or Freddie Mac.

Standard FHA refinances impose no such rule. Any underlying loan type can be refinanced, and barely any equity is needed to do so.

Mortgage rates today are enticing homeowners to reduce their rate and payment. But a low-equity position is locking them out of a refinance.

The FHA refinance is a powerful — but very little know — solution for homeowners. This is the loan with which households with little equity could finally take advantage of current mortgage rates.

What Is A “Standard” FHA Refinance?

FHA offers a variety of refinance types.

The most popular is the FHA streamline refinance. This loan allows homeowners to exchange their higher rate for a lower one when rates drop.

FHA streamline applicants don’t need an appraisal or even income documentation like W2s and pay stubs. The refinance process is streamlined and quick, hence the name.

But these loans are only available to homeowners who already have an FHA loan. They do nothing for homeowners who originally purchased with another loan type but now have little equity. Such loan types are as follows.

  • Option ARMs
  • Bank “portfolio” loans
  • Alt-A loans
  • 80-20 loans

Loans originally opened under programs other than FHA, Fannie Mae, Freddie Mac, or the Veterans Administration are typically not eligible for a refinance without 10-20% equity.

The standard, non-streamline FHA refinance, however, can pay off any type of loan.

A Refinance That Requires Very Little Home Equity

Many people think of FHA mortgage loans as a tool primarily used by first-time homebuyers. However, the FHA mortgage can also be ideal for refinancing, even when the current loan isn’t an FHA mortgage.

FHA refinance loans offer a variety of attractive features to U.S. homeowners. Not only do FHA loans offer options for low-equity positions, they also have less stringent credit requirements and competitive interest rates.

A standard non-streamline FHA refinance with an appraisal allows you to refinance up to 97.75% of the current value of your home.

This is an incredibly loose loan-to-value guideline.

Conventional loans require 5% down if the underlying loan is not also conventional. In addition, you must be double-approved: a private mortgage insurance company must green light your application, even if the lender has already done so.

FHA, on the other hand, is a one-stop shop for your mortgage and mortgage insurance. If the loan is approved, mortgage insurance is too.

Applicants will need a new appraisal to determine their home’s value. Once value is determined, a loan amount can be approved just 2.25% below that number.

For instance, a home worth $225,000 is eligible for a loan amount up to $219,900. The new loan amount can pay off the existing loan balance plus closing costs.

When You Can Use The New Appraised Value

Typically, you can finance up to 97.75% of your current appraised value.can use can’t always use your appraised value to the rule is when the home was purchased less than 12 months ago. In that case,

But there is an exception.

If you purchased the home less than 12 months ago, you must use the original purchase price of the home as the basis of your new loan amount. This applies even if your current appraised value is higher.

For example:

  • Current appraised value: $250,000
  • Purchase price from 6 months ago: $225,000
  • Maximum loan: $219,900 (97.75% of original purchase price)

You can get a higher loan amount if you have made improvements on the home and can show receipts for the cost of the work.

If your appraised value is much higher, you may want to consider a standard conventional refinance. A conventional loan will allow you to use your current appraised value instead of the original purchase price.

Use FHA As A HARP Alternative

One of the most important — but least talked about — advantages to the FHA streamline is that it can act as an alternative to the HARP loan program.

The HARP mortgage is a refinance loan designed to help homeowners with little to no equity. However, homeowners must 1) have a loan that is owned by Freddie Mac or Fannie Mae, and 2) must have taken out that loan prior to June 1, 2009 in order to qualify.

Only about 300,000 homeowners are eligible, nationwide, for the HARP program. There are millions more who can’t take advantage of low rates that have persisted over the past seven years.

Finally, property values are rising. According to the National Association of REALTORS®, values are up six percent since last year.

At this level of home appreciation, many households will climb out of a negative equity position very soon, and be able to take advantage of an FHA refinance.

Surprisingly, An FHA Refinance Can Pay Off A Second Mortgage

A set of homeowners who often can’t take advantage of other refinance types are those with second mortgages.

But a standard FHA refinance loan allows homeowners to combine their first mortgage and a second mortgage into a single loan.

For instance, a family has a first mortgage at six percent, and a second mortgage at nine percent. They apply for an FHA refinance and consolidate both loans into a loan at current FHA rates.

FHA refinance applicants can pay off a second mortgage under the following conditions.

  • The second mortgage is over 12 months old
  • The homeowner has not taken a draw from the second mortgage in the past 12 months
  • Any advance or draw in the last 12 months was for home repairs or rehabilitation

Homeowners who have a newer line of credit or have taken an advance can apply for an FHA refinance as soon as the 12-month waiting period has passed.

What About The Added Cost Of FHA Mortgage Insurance?

One drawback to an FHA refinance is that the loan will be subject to FHA mortgage insurance premiums (MIP).

Two mortgage insurance premiums are required for all FHA loans – an upfront insurance premium and an annual insurance premium.

The upfront mortgage insurance premium is 1.75% of the loan amount. This premium is paid at the time of closing and can be financed as part of the loan.

The annual mortgage insurance premium is paid in monthly installments. The premium varies according to the length of the loan, the amount borrowed and initial loan-to-value ratio (LTV).

Annual premiums for FHA loans are as follows.

  • 15-year term with a down payment or equity position of less than 10%: 0.7%
  • 15-year term with a down payment or equity position 10% or more: 0.45%
  • 30-year term with a down payment or equity position of less than 5%: 0.85%
  • 30-year term with a down payment or equity position of 5% or more: 0.8%

So does it pencil out for a homeowner to refinance and take on FHA MIP?

It depends on the homeowner’s rate compared to currently available rates, just like with any other refinance.

Let’s look at an example of someone refinancing at the full 97.75% loan-to-value.

  • Current loan: $250,000
  • Mortgage rate: 5.5%
  • Monthly principal and interest payment $1,419

The new FHA loan would be issued at these costs, including the 1.75% upfront mortgage insurance fee and 0.85% annual MIP.

  • New FHA loan: $254,375
  • Mortgage rate: 3.5%
  • Monthly principal, interest, and MIP payment: $1,322

This homeowner would save about $100 per month, potentially making this refinance pencil out. Again, refinancing value depends on current mortgage rates, which have recently hit multi-year lows.

FHA Cash-Out Option

You can also obtain a cash-out refinance with an FHA loan. But it requires a lot more equity.

You need at least 20% equity remaining after your refinance (80% loan-to-value), an FHA cash-out refinance can be great way to tap into your home’s equity without having to sell the property.

FHA cash-out refinance loans can be used for a variety of purposes such as:

  • Debt consolidation
  • Home improvement
  • Education costs
  • Buying a new automobile or paying off an existing one
  • Creating a nest egg for savings
  • Investing

FHA cash-out refinance loans are permitted as long as the homeowner has been current on their mortgage payments for the most recent 12 months.

Homeowners are permitted to cash-out refinance if they’ve lived in their home for less than 12 months, providing they’ve made at least six on-time payments.

For newer homeowners, their loan amount will be limited to 80% loan-to-value based on the lesser of the new appraised value or the sales price of the property when acquired.

An FHA cash-out loan is a powerful tool for homeowners who would like to drop their mortgage rate and tap into their home’s equity simultaneously.

What Are Today’s FHA Loan Rates?

FHA refinance loans have low rates and can be great for homeowners looking for a way to refinance with little equity and less-than-perfect credit.

Check today’s FHA mortgage rates now. Your social security number isn’t required to get the process started, and all quotes come with instant access to your live credit scores.

Craig Berry
Authored By: Craig Berry
The Mortgage Reports contributor
With over 20 years in mortgage banking, Craig Berry has helped thousands achieve their homeownership goals.