The first step in determining the worth of a conventional mortgage refinance is to estimate the property value and the borrowers’ equity in the home. Unless the homeowners have more than 20 percent equity in the property, they will have to pay private mortgage insurance, which will add to their monthly costs. An appraisal also will be required.
Mortgage insurance on conventional loans can be eliminated after two years of on-time payments and a loan-to-value ratio of 78 percent or less. Mortgage insurance on FHA loans must be paid for at least five years before it can be eliminated. FHA loans also require upfront mortgage insurance, which can make them costlier than a conventional mortgage.
Still, an FHA loan refinance has some advantages.
“FHA loans have a streamline refinance feature, which allows borrowers to lower their interest rate without an appraisal,” says Sarah Pichardo, a senior loan officer with George Mason Mortgage in Fairfax, Va. “This is a wonderful feature, not available with conventional mortgages, in cases where a borrower’s home has decreased in value.”
The right choice
When choosing between an FHA refinance and a conventional loan, borrowers need to evaluate the cost of the refinance versus the benefit, Pichardo says.
“The borrower and the lender need to do the calculation to see how long it will take for the effect of the lower interest rate to make up for the cost of the refinance,” Pichardo says. “Often, we need to determine the break-even point and estimate how long the homeowners think they will be in the home.”
When weighing the difference between an FHA-insured loan and a conventional mortgage, homeowners should also consider the future of home prices and mortgage rates. An FHA-insured loan is assumable, which could make the home more attractive to future buyers if mortgage rates rise.