If you initially took out an FHA loan to buy your home, you might now be comparing refinance rates to move from an FHA loan to a conventional loan. Here’s what to think about before making the switch.
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, you can, so long as you meet the standards for approval of a conventional loan. These typically include a minimum credit score of 620 and a maximum debt-to-income (DTI) ratio of 43 percent. There are other standard requirements involved, too, including proof of your income and ability to repay the loan.
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.
- Interest rates have dropped significantly. If you’re paying 5.1 percent on your current loan, for example, and you can score a new rate of 4 percent, that can be a huge savings over the lifetime of a loan. 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 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 have lowered your monthly payments enough to compensate, and the tradeoff is that you’ll be able to cancel PMI, eventually, on the conventional loan.
- Conventional PMI: 0.58 percent to 1.85 percent, according to averages from the Urban Institute
- FHA MIP: 0.75 percent upfront and 0.45 percent to 1.05 percent yearly
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.
Cons 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 can add up to thousands of dollars. Depending on your lender, you might be able to roll these costs into your loan, but that will ultimately mean you owe even more with interest charges.
- 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. It won’t happen overnight, either: Some lenders might take 45 days or longer to complete your refinance application.
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.
While many homeowners refinanced in the last two years, the market looks much different now. Interest rates have been on the rise, so crunch the numbers to figure out if you would qualify for enough savings to go through the work of switching to a conventional loan. If you can save money and eliminate mortgage insurance, though, this strategy might be a smart move. 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.