While more developers are turning to the Federal Housing Administration (FHA) for new construction financing, an increasing number of borrowers are also using the FHA to refinance existing loans. But the drawbacks of engaging with the FHA can sometimes outweigh the benefits.
As it stands now, the FHA’s Sec. 223(f) refinancing program offers better rates and terms than government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. All-in rates for the program were at about 5.4 percent as of mid-May, about 30 basis points lower than what Fannie Mae and Freddie Mac were offering.
For cash-out refinances, the 223(f) program features 80 percent loan-to-value (LTV), and a 1.17x debt service coverage ratio (DSCR). In contrast, Fannie Mae and Freddie Mac were offering a maximum 75 percent LTV and usually a 1.30x DSCR for cash-out refis. For cash-in refinances, the FHA will go up to 85 percent, while the GSEs max out at 80 percent.
And unlike the GSEs, the FHA won’t constrain underwriting of cash-out refinances based on what market the deal is located. “Fannie and Freddie will only go to 65 percent LTV in weaker tertiary markets,” says Robyn Cunningham, a vice president at St. Louis-based Love Funding. “But with HUD, as long as the property is producing and stabilized, you’re allowed an 80 percent LTV and to take equity out.”
While HUD offers the best cash-out refinancing option right now, other factors may offset the favorable rates and terms. The tidal wave of loan requests is reportedly overwhelming many FHA field offices and may add time to the FHA’s already lengthy processing cycle. Most refis through FHA take about 4 months, compared to about 3 months for the GSEs, lenders report.
“They are getting a lot more loans coming across their desk, and it will be interesting to find out how efficiently and how quickly they can process this new business,” says Will Baker, a vice president at Bethesda, Md.-based Walker & Dunlop, which received its FHA license when it merged with Column Guaranteed earlier this year.
Still, some suspect the FHA may be able to get deals done a little more quickly these days, especially since the agency segmented all of its healthcare applications, which used to fall under the same umbrella as multifamily financing, to the LEAN program. The division has freed up staff to focus on multifamily applications. And while the FHA’s staffing levels are historically low, the administration was recently given approval to hire 70 new multifamily staffers—65 of whom would work for field offices.
Another problem often cited is the FHA’s bureaucratic process. Many smaller market-rate borrowers looking at Sec. 223(f) for the first time aren’t prepared for the rigorous documentation that the FHA requires. “A lot of them are not used to the upfront due diligence—they’re used to going through a local banker that already knows them,” Cunningham says. “With HUD, they have a bigger checklist to do upfront, and it can be a roadblock to somebody that hasn’t done it before. But the better rates and terms offset that.”
Rule change is changing
Related to the debate over the FHA's pros and cons is the aftermath of a rule change the FHA put out in February, which eased restrictions on the 223(f) program. The change allowed borrowers to refinance a property that was built or rehabbed within the past three years. In the past, the FHA would not insure a loan for a property built or significantly rehabbed within the three-year period prior to the date of application.
Since the rule change was announced, a few glitches have came to light. Borrowers need to have their certificates of occupancy issued as of July 31, 2008, so anything that wasn’t up and operating by that date will need to obtain a waiver. The problem is that the waiver is sent to FHA headquarters, which further delays the closing of the deal.
The bigger problem, howeer, was that borrowers had to apply for the waiver simultaneously with a firm application. The application fee and related charges run around $25,000, which is nonrefundable. That’s a lot to shell out if you don’t know whether the waiver will be granted: Borrowers could be out $25,000, and ultimately fail to get the loan.
The FHA has taken a proactive step in responding to these concerns. It recently said it would consider entertaining a waiver request prior to receiving an application, according to the Mortgage Bankers Association.