You don’t need to have an FHA mortgage to refinance with FHA. And the fact that you only need 3.5% home equity is a compelling reason to consider this refinancing option. For those with conventional loans, FHA refinancing may be better than paying Fannie and Freddie’s risk-based pricing adjustments. But FHA also has its costs.
FHA or Traditional Refinance?
The refinancing choice best for you depends on your credit rating and the amount of equity you have. Regardless of your equity, FHA requires an upfront mortgage insurance premium (MIP). There is also a monthly MIP charge for most loans. If you have at least 20% equity and excellent credit, a conventional refinance is your least costly alternative.
Refinancing an FHA mortgage to a new FHA loan is called a streamline refinance, and there are some rules:
- You must have made at least six monthly payments on your current FHA mortgage, and at least 210 days must have passed since you closed on that loan.
- In addition, if you've had your FHA mortgage for less than one year, you cannot have had any late payments (late payments are defined as at least 30 days past due).
- To refinance an FHA loan older than one year, you’re allowed one 30-day late payment in the last 12 months, but none in the last 90 days.
- The new mortgage must provide what is called a "new tangible benefit" to you.
The streamline refinance requires no appraisal, credit qualifying or employment verification, because FHA is already on the hook if you default. If a refinance makes it easier for you to make your payments, it's also good for FHA. This is the reason for the "net tangible benefit" requirement.
If you streamline an FHA loan that closed on or before May 31, 2009, the UFMIP will decrease to 0.01 percent of the base loan amount.
What's a Net Tangible Benefit?
FHA only allows streamline refinances that leave homeowners in a better financial position.
- When refinancing from a fixed rate to a fixed rate or an ARM to an ARM, the P and I (principal and interest) payment must be reduced by at least 5 percent.
- When refinancing from a fixed rate to an ARM, the new ARM rate must be at least 2 percent lower than the current fixed rate.
- When refinancing from an ARM to a fixed rate, the new fixed rate may not be more than 2 percent higher than the current rate of the ARM.
- Hybrid ARMs are treated like fixed-rate loans if refinanced during the fixed-rate period and like ARMs if refinanced during their adjustable phase.
- Refinancing to reduce the mortgage term, say from 30 years to 15 years, is also considered beneficial and is allowed.
Other Refinance Options
If you have enough equity and need some extra money, you might want a cash-out FHA refinance mortgage, which is allowed to a maximum loan-to-value of 85 percent.
If you wish to roll your refinancing costs into your new FHA mortgage (this is referred to as a “limited cash-out refinance”), that’s okay too, but it will trigger an appraisal requirement. You must have lived in the home for at least a year and you must fully qualify for the new loan. You must also have made all of your payments in the last 12 months on time, and have made at least 6 monthly payments on your current mortgage.
If you refinance to a conventional (non-government) loan, your seasoning requirement is only 120 days if the loan you're refinancing was used to purchase your home.