The Hidden Trap in HARP Refinancing

Thinking about refinancing a low-equity or underwater mortgage through the government’s Home Affordable Refinance Program (HARP)? If you have private mortgage insurance (PMI) on your loan, you might not want to do it just yet.

Here’s why: Refinancing through HARP can significantly extend the length of time you have to carry PMI on your mortgage. PMI can also make it more difficult to refinance through HARP, and limit your choices of lenders — meaning you could end up paying a higher rate than necessary.

If you’re in the market for a HARP refinance, you may think that you’re going to be stuck with PMI for a long time anyway. After all, having little or no home equity means you’re pretty far from the 80 percent loan-to-value ratio — based on the current value of your home — that you need to request that PMI be cancelled on your mortgage.

Automatic PMI Cancellation Based on Original Home Value

What many homeowners don’t realize, however, is that federal law requires that PMI be removed automatically for most borrowers when their loan balance falls to 78 percent of the original value of their home! That’s true even if their home has fallen in value so far that they’re underwater on their mortgage.

What’s more, many borrowers who bought their homes in the years just before the housing bubble burst are at or approaching that point right now — it typically takes 5-9 years to reach the 78 percent mark on a 30-year loan, depending on the size of the original down payment. So if that’s your situation, you might want to hold off and check the numbers before committing to a HARP refinance.

The biggest problem is that if you do a HARP refinance with PMI, you go right back to the start as far as automatic cancellation is concerned. Instead of being able to have PMI cancelled when your loan balance reaches 78 percent of the original home value, you now have to wait until it falls to 78 percent of the new loan balance.

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That will take about 10 years if you go with a 30-year loan — remember, you’re not getting a head start from a down payment this time — but only about four if you opt for a 15-year term. Still, with the cost of PMI ranging from about one-half to one percent of your loan amount each year, it adds up.

Refinancing Can be Harder, More Expensive with PMI

The other thing is that PMI can make it harder to get approved for a HARP refinance, or it can limit your options for choosing a lender. Fred Glick, a mortgage broker and managing member of U S Loans Mortgage LLC, said the big problem can be finding a lender who’ll do a HARP refinance on loans covered by your private mortgage insurer.

“If you don’t have PMI, you can go with anybody,” Glick said. “But if you do have PMI, you have to make sure that someone will accept your PMI.”

Glick said borrowers with PMI often get stuck with their current mortgage servicer, rather than being able to shop around to different lenders to find the best rate. Borrowers who are able to shop around for lenders are usually able to save at least a quarter of a point on their mortgage rate, he said.

It should be noted, though, that PMI has become less of an obstacle to a HARP refinance since the new “HARP 2.0” guidelines took full effect earlier this year. The Mortgage Insurance Companies of America, an umbrella organization for private mortgage insurers, reports that HARP refinances with PMI were up 88 percent in the second quarter of 2012, compared to one year earlier.

The MICI reports there have been 437,000 mortgages with PMI refinanced through HARP since the program began in the spring of 2009. That’s out of a total 1.6 million HARP refinances reported by the Federal Housing Finance Agency, of which 618,000 were approved in the first eight months of 2012.

Deciding Whether to Wait or Refinance Now

What it comes down to though, is that if you’re in a position to qualify for automatic PMI cancellation in the next year or so, you want to proceed with caution before applying for a HARP refinance. Borrowers should take into account the cost of carrying PMI for a longer time and the possibility of paying a higher rate, as well as accounting for the possibility that mortgage rates might rise while they’re waiting to be freed of PMI.

“You need to run the numbers to see if it makes sense,” Glick said.

It should be noted that the HARP initiative is currently scheduled to end on Dec. 31, 2013, so if you want to participate you must complete your refinance by then. Congress has extended the program previously, although it’s not clear if that might happen again, regardless of who’s in the White House next year.

Timewise, closing on a HARP refinance takes about the same amount of time as a standard mortgage refinance, about 45-75 days, depending on the lender and if an assessment is required, Glick said.

Guidelines for Automatic PMI Cancellation

As you might expect, there are a few guidelines for automatic cancellation of PMI, which is required for eligible homeowners under the Homeowner’s Protection Act of 1998. First, the mortgage must have been originated on or after July 29, 1999, which is when the law took effect.

Second — and this is a big one — it only applies when your mortgage balance reaches 78 percent of the original home value through your normal amortization schedule. That means you can’t make bigger payments to speed the process up.

As mentioned earlier, this usually takes about 5-9 years on a 30-year mortgage, depending on the size of your original down payment. You can contact your mortgage servicer or use an online mortgage calculator to find out exactly when that will be in your case.

Third, you have to be current on your mortgage payments, with no missed payments during the past 12 months. You also can’t have any secondary liens on the property, such as a home equity loan or piggyback mortgage.

Your original value is either the selling price of the home or its assessed value at that time, whichever is lower. Also, for borrowers with certain high-risk loans (e.g., Alt-A), the target figure is 77 percent of the original home value.

Finally, the above only applies to homeowners with private mortgage insurance. If you have lender-paid mortgage insurance (LPMI), you’re out of luck.

You can only do one HARP refinance on a particular property, so you want to be sure you’re not locking yourself into long-term costs you might have been able to avoid. If you bought your home in the years just before the housing bubble burst and are thinking about HARP, you owe it to yourself to check into automatic PMI cancellation before you go any further.

Image: Jessica F., via Flickr