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Blake Kleckner

When 5 Years = 9 to 11--The FHA Mortgage Insurance Cancellation Myth

Monday, December 16, 2013 - Article by: Blake Kleckner - DiVita Home Finance - Message

If you are one of the fortunate homeowners who has a FHA loan that was originated before 6/3/13, according to FHA guidelines you are able to cancel your mortgage insurance (MI) when your home's loan-to-value ratio (LTV) declines to 78%, but no sooner than 5 years from the start of your loan. Or, can you? Well, actually not.

FHA has been real clever about selling its low down payment loans under the guise of MI for just 5 years and a LTV of 78% or less when, in fact, if you get a FHA loan you will most likely have MI for 9 to 11 years if you just make your required mortgage payments each month. If you make more than these payments, you can shorten the time it will take for you to cancel your MI, however, most people don't.

So, why will it take 9 to 11 years to get out of the MI? Let's look at an example to find out.

We'll assume that you purchased your home 5 years ago for $320,000. After your 3.5% down payment and the 1.75% up-front mortgage insurance premium add-on, your loan amount would have been in the $314,000 range.

Now, here we are 5 years later, home prices have skyrocketed in the past 2 years, and your home's FMV, based upon comps in the area is, conservatively, $480,000. Because you just made your scheduled monthly payments, your loan balance is approximately $281,650. Naturally, you would think the LTV is 59% ($281,650 divided by $480,000), and your MI should easily be eliminated once you get an appraisal to prove this FMV. Unfortunately, you would be wrong!

How can that be, you ask? The answer is quite simple. Your home's LTV after 5 years is not determined by the actual value of your home at that time, but rather by what the FMV was when the loan was originated. In the case of a purchase, it is the purchase price. Therefore, the appraised value is of no value when calculating the LTV for the purpose of eliminating MI.

The actual LTV is 88% ($281,650 divided by $320,000)--a far cry from 59%. Quite shocking, wouldn't you agree?

There are only 2 ways you can eliminate the monthly MI on your FHA loan. First, if you believe that your home's FMV is high enough to result in a LTV no greater than 80%, the fastest way is to refinance into a conventional loan. Second, you can wait until your loan balance is low enough so that the LTV is 78%. In the example above, it will take another 4 years and 3 months to achieve this LTV because the FMV used in the calculation has to be the $320,000 purchase price. This is precisely how 5 can = 9 to 11, as the title of this blog indicates.

I am currently working with 2 clients right now who are refinancing out of their FHA loans into conventional ones. Both loans have very low interest rates--3.125% and 3.375%--and because 30-year fixed rate loan interest rates are at historic lows, they have opted to refinance even though their interest rates will increase. It makes good sense, though, because they will shed themselves of their outlandish non-tax deductible monthly MI payments, and replace them with completely tax deductible mortgage payments, as well as have lower monthly mortgage payments in total.

All that to say this. If you have a mid-FICO score of 620 or more, at least 5% for a down payment, and a minimum of 2 months of mortgage payments + property taxes + homeowners insurance + MI (+ HOA dues for condos) after your loan closes, by all means do not get an FHA loan. Even though the interest rate will be lower than a conventional loan, you could quite easily pay more in total because the monthly MI will, most likely, be significantly higher than private MI, to say nothing of the fact that 1.75% of the loan amount after the down payment will be added to the loan amount .

Of greater importance, though, is that FHA MI is now for the life of the loan for purchases with less than a 10% down payment, and refinances for homes with LTVs greater than 90%. You read it right--THE LIFE OF THE LOAN. Here's the good news, though, if you put 10% or more down to purchase your home, or refinance it when its LTV is 90% or less, which will occur about 5 years into the loan, then the MI WILL ONLY BE FOR 11 YEARS.

Come to think of it, that's not really good news because you can purchase a home with just 5% down, pay less MI monthly, not have to pay the FHA 1.75% of the loan amount after the down payment, and be able to eliminate the MI much sooner than 11 years with a conventional loan. That's even better news!

My advice to you is be extremely wary of anyone attempting to sell you a FHA loan. You could very well qualify for a conventional loan which will be far less costly, and a much better investment for you.

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