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With their lenient requirements around down payment and credit scores, an FHA loan can be an ideal starter mortgage. But the steep fees that accompany FHA loans add up.
Can you refinance an FHA loan into a conventional loan?
Before comparing conventional loan rates, you might be wondering: Is it even possible to refinance from an FHA loan to a conventional loan?
Yes, it is, so long as you meet the standards for approval of a conventional loan. Some of most common minimum requirements for conventional loan approval include:
- A credit score of at least 620
- Equity ratio of at least 20 percent in your property (that is, you own 20 percent of it outright)
- Debt-to-income (DTI) no higher than 45 percent
- Proof of income and insurance
When is it a good time to refinance an FHA loan to a conventional loan?
Just because you can be approved for a new loan doesn’t mean you should refinance. Here are a few cases when it might make sense to move from an FHA to a conventional mortgage:
- Your credit score has improved significantly since you applied for your FHA loan. Let’s say your credit score was 600 when you took out your first loan. Four years later, it’s now 670. That’s a huge difference that can help you qualify for a more affordable loan. (If your score has climbed above 700, even better.)
- You could get a lower interest rate. This is a tricky one – mortgage rates in 2022 rose to their highest point in two decades, so low rates are hard to find. However, it’s worth checking. Look at the market now versus when you applied, and use Bankrate’s refinance calculator to estimate your savings with a lower rate.
- You’re going to stay there long enough to recoup your closing costs. If there are no plans of moving in your future and you still have a long time left on your current loan, a conventional loan refinance can be a smart decision. However, if you’re planning to move in the next couple of years, refinancing might not be wise, because you might not have enough time to hit the break-even point where your savings outweigh the upfront closing costs on a new loan.
Benefits of refinancing an FHA loan to a conventional loan
The main advantage of refinancing from an FHA loan to a conventional loan is that it’s one of the only ways to remove FHA mortgage insurance.
With a conventional loan, once your balance reaches 80 percent of your home’s original value, you can cancel private mortgage insurance (PMI). This option doesn’t exist in most cases for FHA loans, so you’ll continue to pay premiums unless you refinance to another type of loan.
If you refinance your FHA loan to a conventional loan and still have to pay mortgage insurance due to your equity level, you might find that the premium costs more now than what it cost for your FHA loan. Refinancing, however, could lower your monthly payments enough to compensate, and the tradeoff is that you’ll be able to cancel PMI, eventually, on the conventional loan.
Most borrowers pay an FHA mortgage insurance premium (MIP) of 0.8 percent. On a $400,000 loan, that’s $3,200 a year, or $267 a month. In other words, FHA mortgages aren’t cheap.
Another benefit to refinancing your FHA loan to a conventional loan is that conventional mortgages allow you to tap up to 80 percent of your home’s equity through a cash-out refinance without paying mortgage insurance. Conventional loans also have higher loan limits, so you can take out a larger amount compared to an FHA loan.
Disadvantages of refinancing from FHA to conventional
While conventional refinance rates tend to be lower than FHA refinance rates, it’s not all roses if you switch to this new type of loan. Consider these drawbacks:
- You might still pay mortgage insurance for a while. Those PMI payments will still add up, so be sure to ask a lender for an estimate of how much your premiums would be if you still haven’t hit the 80 percent mark.
- You will need to pay closing costs. Refinancing doesn’t come cheap. You’ll need to pay closing costs, which are substantial on large mortgages. As of the end of 2021 (the most recent data available), the average refinancing closing costs were $2,398. This represents an increase of almost 5 percent from the year before. Depending on your lender, you might be able to roll these costs into your loan, but that will ultimately increase your new monthly payment.
- You’ll have to go through the entire loan process again. Remember all the work you had to do to get approved for your first loan? Get ready to do it again. Conventional refinancing involves a lot of paperwork and a lot of back-and-forth exchanges with your lender. In November 2022, according to Ice Mortgage Technology, the average number of days to close a conventional refinance loan was 51 days, vs 44 days the previous year.
Alternative FHA loan refinancing
If refinancing your FHA loan to a conventional loan isn’t right for you, you can still take advantage of lower interest rates by doing an FHA streamline refinance. This program offers a faster way to refinance your FHA loan because it does away with more stringent underwriting, such as the need to verify your income and credit or do an appraisal.
To qualify for an FHA streamline refinance, you’ll need to meet the following requirements:
- You have an FHA loan.
- You’ve been making your payments and your loan is in good standing (not delinquent).
- Refinancing results in a “net tangible benefit,” such as lowering your monthly payment or changing from an adjustable-rate loan to one with a fixed rate.
- You’re not looking to take out more than $500.
Final word on refinancing FHA loans
The decision to refinance from a FHA loan to a conventional loan can make sense for many homeowners, especially if you are currently paying mortgage insurance premiums and you see an opportunity to lower your interest rate. That being said, you should always use a mortgage calculator to see if you’ll actually save money.
Carefully consider the pros and cons, estimate your costs and explore all of your options, including an FHA streamline refinance, so you make the best possible decision for your circumstances.