5 Reasons to Refinance Your FHA Loan to a Conventional Mortgage
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Refinancing your FHA loan to a conventional mortgage may clear room in your monthly budget, especially with interest rates dropping to historic lows. If your home’s value has grown, tapping equity with a conventional loan refinance may also save you a bundle in mortgage insurance costs.
Here are five reasons to refinance your FHA loan to a conventional loan.
- You qualify for conventional financing
- You can get rid of FHA mortgage insurance
- You can save money with private mortgage insurance
- You aren’t yet eligible for an FHA streamline and rates are dropping
- You need extra cash and home values have gone up
1. You qualify for conventional financing
A major difference between FHA loans and conventional loans are the qualifying guidelines. Borrowers often take out loans insured by the Federal Housing Administration (FHA) to compensate for lower credit scores or for the flexibility to qualify with the income of someone who won’t live in the home.
However, you may qualify for conventional financing if:
- Your credit score is higher. You’ll typically be rewarded with the lowest conventional interest rate with a credit of 740 or above. A minimum credit score of 620 is needed for conventional financing.
- You don’t need a co-borrower anymore. If your income has risen since you bought your home, a conventional refinance loan might help remove a parent or relative co-borrower from responsibility for your mortgage.
- Your spouse has racked up extra debt. In a community property state, your spouse’s debt is counted against you with an FHA loan regardless of whether they’re on the loan. You can leave your spouse and their debt off a conventional loan refinance, even if you own a home in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington or Wisconsin. Alaska may also apply community property laws if a special agreement is signed.
2. You can get rid of FHA mortgage insurance
If you refinance an FHA loan to a conventional loan, you may be able to eliminate monthly mortgage insurance. Conventional loans don’t require mortgage insurance if you have at least 20% equity in your home.
One of the drawbacks of FHA financing with a minimum down payment is having to pay monthly FHA mortgage insurance for the life of the loan. Mortgage insurance protects the lender against default, and the FHA mortgage insurance premium (MIP) is charged regardless of how much equity you have.
You may get rid of FHA MIP if you:
- Get a conventional home appraisal to confirm you have 20% equity. Lenders will normally order an appraisal as part of the conventional refinance loan process.
- Pay down your current loan to 80%. If you don’t quite have 20% equity, it might be worth it to pay down the loan balance with cash and take out a conventional refinance loan to avoid mortgage insurance.
3. You can save money with private mortgage insurance
Conventional mortgage insurance, more commonly referred to as private mortgage insurance (PMI), may be a cheaper alternative to FHA MIP, especially if you have a high credit score. The table below compares PMI with MIP for a $200,000 30-year, fixed-rate loan based on your home’s equity.
The PMI premiums drop as your equity grows, but the MIP stays the same. A good credit score and increasing equity are a recipe for saving money with a conventional refinance.
An added bonus: You’ll automatically end up with a conventional loan without PMI once you’ve paid your loan balance down to 78% of the original purchase price. You can also request the cancellation of your PMI if you’ve made extra payments to bring your loan balance down to 80% of the original value of your home.
4. You aren’t yet eligible for an FHA streamline and rates are dropping
An FHA streamline refinance is typically a fast way to reduce your mortgage payment, as no appraisal or income documents are required. But there are a few reasons why refinancing to a conventional mortgage might make more sense:
- It’s too soon for you to do an FHA streamline. If you closed on an FHA loan within the past year, you have to make seven payments before you’re eligible for an FHA streamline. A conventional loan refinance may provide you with an opportunity to snag current mortgage rates at all-time lows.
- You don’t want to pay FHA mortgage insurance again. Every FHA refinance requires payment of both the annual and upfront mortgage insurance premium (UFMIP) again. You won’t have to shell out the UFMIP of 1.75% with a conventional loan refinance.
- You want to roll closing costs into your refinance loan. Refinance closing costs can be rolled into a conventional refinance loan. With an FHA streamline, the only way to finance closing costs is with a higher interest rate.
5. You need extra cash and home values have gone up
Median home prices have continued to rise since 2016, according to data from the National Association of Realtors. This has left many homeowners with a healthy chunk of equity. If you have the urge to make home improvements, you might be able to tap some home equity with a cash-out refinance.
Some advantages of a cash-out refinance of an conventional loan versus an FHA loan include:
- Borrowing up to 80% of your home’s value with no mortgage insurance. An FHA cash-out refinance requires mortgage insurance, even with 20% equity.
- Higher loan limits than FHA allows. In most areas of the country, the FHA loan limit is $331,760, compared with $510,400 for conforming conventional loans. If you live in higher-cost areas, higher loan amount limits may apply.
- Saving a few dollars on the home appraisal cost. The FHA has more stringent appraisal requirements, and the fee is $300 to $700, compared with an average of $300 to $400 for a conventional home appraisal.