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No Cost FHA Refi Lowers Your Rate and Loan Balance?

Frustrated with FHA?

Why? Are you one of those people that hate their FHA mortgage because it has mortgage insurance?  I never understood this frustration.

FHA loans are amazing in so many ways, and have the ability to offer creative financing solutions that most other loan programs cannot do.

Most people feel like they “end up” with a FHA loan, or “have to” use FHA financing to buy a home.  What you don’t know is how lucky you possibly just got by using a FHA loan to purchase your home.

The best example is the ability to lower your interest rate with an FHA loan without an appraisal, no income verification, and much less paperwork.

I recently had the opportunity to utilize this strategy for lowering the payment, eliminating up front mortgage insurance, and reducing your principal balance, all at the same time, at no cost.

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Don’t misunderstand, this is not a free loan, it’s just a little creative financing that ends up saving you a lot of money, and resulting in no cost, after the mail in rebate.  I know what you’re thinking, mail in rebate?  I get it, that sounds strange.

Let me explain how this creative FHA refinance strategy works.

Who’s Eligible?

Qualifying for this program is easier than most other loan programs.  There are 3 main qualifying criteria that you must meet before being eligible for a FHA streamline refinance:

  1. You must have made a minimum of 6 on-time payments on your current FHA loan
  2. You must be able to reduce your interest rate by a minimum .50%
  3.  You cannot increase the loan amount by more than the mortgage insurance

This special refinance program does not require any income information, and there is no appraisal.  The lender will have to verify your employment.  Some lenders will have minimum FICO guidelines, but never fear, there are lenders out there that will manually underwrite FHA streamline refinances with scores under 600.

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Get Your Mail In Rebate

FHA loans all require impounds, which is a fancy way to say that your property taxes and homeowner’s insurance included in your monthly payment.  This means that your lender pays your total property tax bill, and homeowner’s insurance premium for the year, and collects one twelfth of that total each month as part of your monthly payment.

When you do a streamline refinance, your new lender will have to collect an up front amount to fund the new escrow account so that it has enough money to pay the property taxes twice a year, and homeowner’s insurance once a year.  Depending on which month you close on your new loan, the number of months of impounds will be collected.

This is a common guide for collecting property taxes

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Closing Month First Payment Date Impounds Required
January March 6 Months
February April 1 Month
March May 2 Months
April June 2 Months
May July 3 Months
June August 4 Months
July September 5 Months
August October 6 Months
September November 7 Months
October December 8 Months
November January 9 Months
December February 4 Months

The amount a new lender will require to fund your impound account will vary based on when you close on your refinance.  NOTE:  Most lenders will also add a “pad” of 2 months of taxes and insurance.  The above numbers do not include this padding.

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Keep in mind that these are not fees, an impound account is your money that is being held in a trust account for the sole purpose of paying your taxes and insurance when they are due.

While this is not a fee, it is an unavoidable cost, until you get you mail in rebate.  The mail in rebate is the reimbursement of your impound account

The refund you receive from your previous lender, will reimburse you for any money you will bring in to escrow to close your loan.  You will have to temporarily lend this money to your self for a month to 6 weeks before you receive your reimbursement.

Up Front Mortgage Insurance Acrobatics

All FHA loans have mortgage insurance.  All you FHA haters out there, you’ve made your point.  Mortgage insurance is paid in two different ways.  There is a 1.75% upfront mortgage insurance premium that was most likely financed into your loan amount.

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Did you notice that when you first got your FHA loan, that the actual note amount was more than the purchase price minus your down payment?  That’s why, most borrowers will finance the upfront mortgage insurance.  The only alternative is to pay the upfront mortgage insurance as a closing cost instead of financing it into the loan.

This is where the magic of this strategy really comes from.  The secret ninja weapon of lowering the principal balance of your loan by potentially thousands of dollars, is what I’m going to show you how to do.

Upfront Mortgage Insurance Refund Chart

If you refinance your FHA loan within the first 36 months, you will get a credit for any remaining upfront mortgage insurance you financed into your original loan.  The upfront mortgage insurance of your new loan, will be offset by this credit, which is a % of the original financed Mortgage Insurance Premium amount.

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Months After Closing MIP Refund Months After Closing MIP Refund Months After Closing MIP Refund
1 80% 13 56% 25 32%
2 78% 14 54% 26 30%
3 76% 15 52% 27 2%8
4 76% 16 50% 28 26%
5 72% 17 48% 29 24%
6 70% 18 46% 29 24%
7 68% 19 44% 31 20%
8 66% 20 42% 32 18%
9 64% 21 40% 33 16%
10 62% 22 38% 34 14%
11 60% 23 36% 35 12%
12 58% 24 34% 36 10%

Pay Upfront MIP with Lender Credit

This is where this strategy really goes off the rails for some people, and for others, it makes perfect sense.  This example is something that I just structured earlier this week.  Let me set this up for you,

The home was purchased a year ago, for the maximum FHA loan limit in their County.  The principal balance on the current loan is $5,300 above the allowable loan limit for the County.

The upfront mortgage insurance premium refund came out to about $6,200.  This refund is transferred by the lender at the time of close, it’s not something you need to worry about.

The way I thought about it is, I can use this UMIP refund, to offset the $5,300 overage above the allowable FHA loan limit, and it even cut into the new mortgage insurance premium being charged.

Most lenders will simply apply this refund to the new mortgage insurance premium, so that you’re not financing the entire 1.75% upfront premium.

Now that I lowered the principal loan amount by $5,300, now I have to look at paying the remainder of the upfront premium with a lender credit.

A lender credit is created when you take a premium interest rate, above market, to generate this closing cost credit.  In this case, they had an interest rate of 4.25%.  Most would agree, this is a pretty good rate, and I would agree.

As I write this article, I was able to create a lender premium at 3.50%, sufficient enough to cover the upfront mortgage insurance, and keep the principal balance at the new balance, which is $5,300 less than where we started.

What’s left is a $6,000 balance that is due at escrow.  I know it sounds a lot, but believe it or not, this is a no cost loan.

Let’s start with the impound account reimbursement from the previous loan.  In my example, the impound balance was $4,100.  It may take 4-6 weeks to get this money back, so you’re kind of lending this money to yourself for a few weeks.

For the sake of example, we’re going to close this streamline refinance as close to the end of July as we can.  The homeowner will make the July payment, because we are shooting for end of the month.

Pro Tip:  When paying off FHA loans, the old lender will charge an entire month of interest to you, regardless of what day of the month you close on the new loan.  By closing at the very end of the month, you do not leave any money on the table in the form of interest paid for days that you did not owe on that loan.

If we close at the end of July, your first mortgage payment on the new loan is due on September 1st.  In my example, the monthly mortgage payment is $4,100.  So, instead of making an August payment, I only need less than $2,000 to cover the remainder of the closing costs for this loan.

The homeowner comes in with less than half a month’s payment, and the amount of the impound reimbursement check, with the next payment due on September 1st is $260 a month less each month that it was before.

And most importantly, we didn’t pay any upfront mortgage insurance, and lowered the principal balance of the loan by over $5,000!

Don’t Be Afraid to Rethink Your Refinance Strategy

A lot of what worked in this specific scenario is that this homebuyer is eligible to refinance into a loan without mortgage insurance inside of the next year.  On a best case scenario timeline, we are refinancing this loan in early 2017.   I now have the ability to refinance them into a conventional loan after the beginning of the year, because we reduced the principal.

This homeowner will save a little bit over $6,300 over the next 6 months with this strategy.  If they decide to hang on to this loan for a little while, we are still saving over $260 a month, for as long as they keep the loan.

Your starting rate is the most important part of this strategy, because the lender needs to have room to generate enough lender credit to cover all of these costs.  If you don’t mind financing your upfront mortgage insurance, you would be able to reduce your interest rate even further, and save a higher monthly amount for as long as you keep the loan.

Because we have a known timeline, the math worked out on this strategy because it actually helps us prepare for a refinance in the future.

My prediction is that interest rates will continue to drop until the Presidential election in November, and possibly even into the new year.  EU instability is going to fuel serious savings opportunities for both homeowners and homebuyers.

Not sure if you should refinance or not?  Take the Quiz!

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About Your Expert

Scott Schang

A 20 year veteran of the Mortgage and Real Estate industry, I am passionate about educating and empowering consumers. I have been writing about consumer protection issues, and making sense of complicated real estate and mortgage topics on this website since 2007

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