FHA REFINANCES & SUBORDINATE FINANCING LIMITATIONS

Written By: Stacey Sprain,
Certified Ambassador Loan Processor (CALP)

The question of maximum allowed CLTV for an FHA rate-term refinance came to my desk today and I knew the answer off the top of my head. Yet, I always like to provide my answers in writing as provided directly from a HUD resource. So I took off on what turned into a “wild goose chase” to find a written resource I could provide to my colleague. Little did I know how frustrating it can be for all of you less-seasoned FHA pros to find these answers on the fly! HUD sure doesn’t make these things easy for you folks, do they? Most guidelines are fairly clear but a few of these refinance guidelines are provided in a “less than desirable format” to say the least.

What should have been quick turned into a multiple hour ordeal so when I finally derived a clear answer, I knew I’d found my subject for this weeks blog. Hopefully this article will help a lot of you folks avoid the “wild goose chase” I found myself on!

Before we exam the “rules” for each type of FHA refinance, let’s take a look at the standard refinance TV limits for all areas:

States with Average Closings Costs At or Below 2.1% of Sales Price include Arizona, California, Colorado, Guam, Idaho, Illinois, Indiana, New Mexico, Nevada, Oregon, Utah, Virgin Islands, Washington, Wisconsin, and Wyoming

* 98.75 percent: For properties with appraised values equal to or less than $50,000.
* 97.65 percent: For properties with appraised values in excess of $50,000 up to $125,000
* 97.15 percent: For properties with appraised values in excess of $125,000.

States with Average Closings Costs Above 2.1% of Sales Price include Alabama, Alaska, Arkansas, Connecticut, District of Columbia, Delaware, Florida, Georgia, Hawaii, Iowa, Kansas, Kentucky, Louisiana, Massachusetts, Maryland, Maine, Michigan, Missouri, Minnesota, Mississippi, Montana, North Carolina, North Dakota, Nebraska, New Hampshire, New Jersey, New York, Ohio, Oklahoma, Pennsylvania, Puerto Rico, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Vermont, Virginia, and West Virginia.

* 98.75 percent: For properties with appraised values equal to or less than $50,000.
* 97.75 percent: For properties with appraised values in excess of $50,000.

Here are the subordinate financing max CLTV limits for each type of refinance along with the source I referred to for the information:

FHA Streamline Refinances
Subordinate financing may remain in place without regard to the total indebtedness against the property on streamline refinances, with or without appraisals.
Refer to Handbook 4155.1 REV-5, Paragraph 1-12. D. 11.

FHA Cash out Refinances
Subordinate financing may remain in place, but subordinate to the FHA insured first mortgage, regardless of the total indebtedness or combined loan-to-value ratio, provided the homeowner qualifies for making scheduled payments on all liens.
Refer to Mortgagee Letter 2005-43

FHA Rate/Term Refinance
Subordinate liens, including credit lines, regardless of when taken, may remain outstanding provided the insured mortgage meets the eligibility criteria for mortgages with secondary financing as described in HUD Handbook 4155.1 REV-5, Paragraph 1-13. (See below which has been copied directly from paragraph 1-13) Basically, if the 2nd lien that needs to be subordinated isn’t held by a government body or non-profit organization, it cannot be re-subordinated if the subordination will result in a CLTV that exceeds the maximum allowed LTV limit for the area. (I said that in three sentences yet below you’ll find several paragraphs stating the same thing!)

1-13 SECONDARY FINANCING.
Any financing (other than the FHA-insured first mortgage) that creates a lien against the property is considered secondary financing and not a gift, even if it is a “soft” or “silent” second (i.e., has no monthly repayment provisions) or has other features forgiving the debt.

Documentation from the provider of the secondary financing must show the amount of funds provided to the borrower in each transaction and copies of the loan instruments are to be included in the endorsement binder. Costs incurred for participating in a downpayment assistance secondary financing program may only be included in the amount of the second lien. FHA reserves the right to reject any secondary financing that does not serve the needs of the intended borrower or where it believes the costs to the participants outweigh the benefits derived by the homebuyer. Permissible secondary financing arrangements include:

A. Government Agencies. Federal, state, and local government agencies, as well as nonprofit agencies considered instrumentalities of government (see B, below), may provide secondary financing for the borrower's entire cash investment. The second lien itself must be made or held by the eligible governmental body or instrumentality. Neither governmental units nor their established nonprofit instrumentalities may use “agents,” including other nonprofits or for-profit enterprises to make the second lien regardless of the source of those funds. In other words, even if the funds used for the secondary financing were derived from an acceptable source such as HUD HOME funds or from a unit of government or the eligible nonprofit instrumentality, the subordinate lien must be in the name of the eligible entity, i.e., the state, county, city or eligible nonprofit instrumentality must be the lien holder. This authority cannot be delegated to another party that is not itself permitted to provide this level of secondary financing. These other entities, however, may be used to service the subordinate lien if regularly scheduled payments are to be made by the mortgagor. Loans secured by secondary mortgages are subject to the conditions described below.

1. The FHA-insured first mortgage, when combined with any second mortgage or other junior liens from government agencies may not result in cash back to the borrower. The sum of all liens cannot exceed 100 percent of the cost to acquire the property. The cost to acquire is the sales price plus allowable borrower-paid closing costs, discount points, repair and rehabilitation expenses, and prepaid expenses. The cost to acquire may exceed the appraised value of the property under these types of government assistance programs. The FHA insured first mortgage cannot exceed the FHA statutory limit for the area where the property is located. The combined indebtedness, however, may exceed the FHA statutory limit.

2. The required monthly payment under both the insured mortgage and the second mortgage or lien, plus other housing expenses and all recurring charges, cannot exceed the borrower's reasonable ability to pay.

3. The source, amount, and repayment terms must be disclosed in the mortgage application, and the borrower must acknowledge that he or she understands and agrees to the terms.

B. Nonprofit Agencies. Nonprofit agencies that meet the criteria described in paragraph 1-5 B and are considered instrumentalities of government may provide secondary financing under the terms outlined in A, above. The appropriate HOC is responsible for approving the nonprofit agency, as well as determining if it can be considered an instrumentality of government. To obtain this status the nonprofit must be an entity “established by a governmental body or with governmental approval or under special law to serve a particular public purpose or designated by law (statute or court opinion).” FHA also requires that the unit of government that established the nonprofit also must either exercise organizational control, operational control, or financial control of the nonprofit in its entirety or, at minimum, the specific homebuyer assistance program that is using FHA’s credit enhancement. The HOCs review applications from nonprofits that purport to be instrumentalities of government and make approval decisions based on information submitted by the nonprofit. Nonprofit agencies not considered instrumentalities of government that otherwise meet the criteria described in paragraph 1-5 B may provide secondary financing under the same conditions as described in A, above, provided the borrower makes a cash investment of at least 3 percent of the acquisition cost and the combined amount of the first and second mortgages do not exceed the statutory loan limit for the area where the property is located. The jurisdictional HOC is responsible for approving the nonprofit agency.

C. Other Organizations and Private Individuals. Other organizations and private individuals may provide secondary financing under the following conditions:
1. The combined amount of the first and second mortgages do not exceed the applicable LTV ratio and the maximum mortgage limit for the area.

2. The repayment terms of the second mortgage must not provide for a balloon payment before ten years (or other such term acceptable to FHA), unless the property is sold or refinanced, and must permit prepayment by the borrower, without penalty, after giving the lender 30 days advance notice.

3. The required monthly payment under both the insured mortgage and the second mortgage or lien, plus other housing expenses and all recurring charges, cannot exceed the borrower's reasonable ability to pay. Any periodic payments due on the second mortgage are due monthly and are essentially the same in dollar amount.

FHASecure Refinances
Under certain conditions explained below, FHA will insure first mortgages where (1) the existing note holder writes off the amount of indebtedness that cannot be refinanced into the FHA insured mortgage; or (2) either the FHA-approved lender making the new mortgage or the existing note holder may take back a second lien that includes closing costs, arrearages or previous secondary financing if the indebtedness exceeds FHA prescribed LTV and maximum mortgage amount limits.

If the new maximum FHA loan is not enough to pay off the existing first lien, closing costs and arrearages, the lender may execute a second lien at closing to pay the difference. The combined amount of the FHASecure first mortgage and any subordinate non-FHA insured lien may exceed the applicable FHA loan-to-value ratio and geographical maximum mortgage amount. If payments on the second are required, they must be included in qualifying the borrower. If payments are deferred, they must be so for no less than 36 months to not be considered in the qualifying ratios. Borrowers need not yet have missed any mortgage payments to be eligible for this type of subordinate financing
Refer to Mortgagee Letter 2007-11

About the Writer. As one of NAMP's volunteer writers, Stacey Sprain is currently a NAMP member in good standing and is a NAMP Certified Ambassador Loan Processor (CALP). If you would like to become a volunteer writer for NAMP, please email us at: blog@mortgageprocessor.org.