Mortgage 411 Center

It’s official:  effective April 1, 2009 the maximum loan to value ratio (LTV) on all cash-out refinances to be insured by FHA may not exceed 85% of the home’s value.  Currently the maximum LTV is 95%.  What does this mean in plain English?  Quite simply if you are a homeowner who does not have a lot of equity in your home and you also do not have cash to pay other debts in order to qualify for the mortgage AND you would like to refinance to take advantage of the lower interest rates , you are running out of options.

Why is this important?

• In today’s declining real estate market there are many people who either bought while prices were high, put little or no money down, or both and currently do not have a lot of equity in their homes.  Changing the loan to value ratio from 95% to 85% is going to severely limit the number of people who are able to refinance.  To put it in terms of numbers, say you own a home worth $220,000.  Currently you would be able to refinance as long as the new loan amount doesn’t exceed $209,000 ,  under the new rules that changes  to $187,000.  Even if the value of your home has not declined, if you bought it with only a 5% downpayment you would not be able to refinance with an FHA cash-out loan since you would not meet the new LTV requirements.

• Cash-out does not necessarily mean that the borrower is getting a check  (cash) at closing.  It simply means that more than the balance of the mortgage and closing costs are included in the new loan amount.  While you may not think that you need to or may not want to do a cash-out refinance, you may have to do a cash-out refinance if you have other liens against the property which need to be paid or you have other outstanding loans, credit card bills etc which will need to be paid in order to qualify for the loan.

• FHA loans have less strict credit standards than conventional loans, and the terms are generally more favorable.  This new rule is going to hurt those who probably could use the help the most.

Please note, you may have also heard about the President’s new mortgage plan that will allow homeowners to refinance up to 105% of the value of your home.   This may be an option for homeowners with little to no equity BUT this option does not allow for cash-out at all no matter what the loan-to-value.   What I am seeing is that many people who are unable to afford their mortgage payment also have other debts that they have incurred which is making it difficult for them to qualify for a new loan.  Since this program prohibits cash-outs which could otherwise be used to pay down the debts, the pool of borrowers who can qualify for this program is limited.

Bottom line.  If you are thinking about refinancing to lower your mortgage payment and have been putting it off and know that you do not have perfect credit, 20% equity in your home, or have other outstanding bills that need to be paid you better act now!

As a mortgage professional who actively networks online, I have the opportunity to read many mortgage and real estate related blogs and websites.   The one thing that I noticed is that although there is a lot of information out there, it can sometimes be difficult for the average consumer to understand.  While other mortgage professionals will understand terms like LTV, PITI, PMI and FICO we often take for granted that the consumer will understand them as well. 

This is not only a problem online, but it also occurs in speaking with customers on a day to day basis.  Out of habit, mortgage loan officers tend to  rely on mortgage speak , forgetting that the customer probably has no idea what the loan officer is saying.   Here are some typical examples:

• If you purchase this home, your PITI will be $1254.76 per month.
• You will have to pay PMI on your loan since your LTV is higher than 80%.
• Because of your FICO, your interest rate is going to be 6.5%.

Allow me to translate.

PITI stands for Principal Interest Taxes and Insurance.  It is basically the amount that you will pay to the mortgage company each month.  Most online mortgage calculators where you plug in the loan amount and interest rate will only give you the amount of Principal and Interest (PI).  But the PITI is the true cost of the loan.

PMI stands for Private Mortgage Insurance.  You will have to pay this if your LTV (that’s loan to value) is greater than 80%.  For example if you are buying a $100,000 house  with a downpayment of $10,000 you would have a loan amount of $90,000 while your home is worth $100,000.  The ratio of your loan to value is $90,000/$100,000 or 90%.  PMI protects the lender in case you go into default.  It is not to be confused with homeowners insurance which you are also required to pay but which protects the homeowner in the event something were to happen to the house.

FICO stands for Fair Issac Corporation which developed the most widely used credit score.   Your lender may refer to your credit score as a FICO score, even if he uses a slightly different model.   Generally, the higher your FICO score the lower your interest rate and vice versa.

To learn more about some common mortgage terms and their meaning please view our mortgage glossary.  Before you know it, you’ll be talking like a loan officer too or at least you’ll be able to understand the mortgage process a little better.