Equity

• When you take out a mortgage, your lender records a security interest on your home, which means that your lender has the right to sell your home if you renege on the loan agreement. However, a foreclosure sale may not raise enough funds to cover your mortgage debt if you live in an area where home prices have fallen. Furthermore, your lender has to pay overdue taxes and settle other liens with the sale proceeds, which also means that your lender could take a loss on a foreclosure sale. Consequently, most lenders only allow you to borrow 80 percent of your property value unless you buy mortgage insurance, in which case you can borrow up to 96.5 percent of the value of your home.
  
  

Refinance

• Under FHA rules, a lender cannot assess a penalty fee if you decide to refinance your loan. However, if you refinance your FHA loan but you have less than 20 percent equity in your home, then the lender may require you to buy private mortgage insurance. This insurance works in the same way as the FHA insurance except that you buy it from a private insurer rather than the FHA. Once you factor in the new insurance premium and the closing costs, you may end up losing money if you refinance your FHA loan.
  
  

Cancellation

• Under federal laws, private mortgage insurers must cancel your mortgage insurance premiums once you have 22 percent equity in your home. Rules vary slightly for FHA loans but the lender must cancel your insurance premiums when you reach 78 percent equity if you have a mortgage with a term of 15 years or less. If you have a mortgage with a term greater than 15 years, your lender must cancel the FHA premiums once you have held the loan for at least five years and have at least 22 percent equity in your home. Therefore, if you have enough equity to avoid paying for mortgage insurance, then your lender will cancel the insurance anyway so you can avoid the cost of refinancing.
  
  

Considerations

• Rules pertaining to the cancellation of FHA insurance premiums only took effect on January 1, 2001. On older loans, the lender can require you to keep paying insurance premiums for the life of your loan. If you have equity in your home, your lender may voluntarily allow you to stop paying the premiums if doing so prevents you from refinancing your loan with a new lender. However, even if you have a pre-2001 loan, consider the overall cost of refinancing versus your potential savings before you enter into a new loan agreement.