An FHA loan may have been the right choice at the beginning of your homeownership journey, but the time may come when a conventional loan better fits your needs. Refinancing can help you get a better interest rate and terms, as well as eliminate your mortgage insurance premium (MIP) when your home’s equity has reached 20%.
Can I refinance an FHA loan to a conventional loan?
Yes, it’s possible to refinance your FHA loan to a conventional loan — though you can’t do a cash-out refinance on an FHA loan. Refinancing your FHA loan can be a smart choice for many reasons, especially when you have 20% equity in your home. When you reach 20% equity, you can refinance to remove your MIP and you won’t have to pay for private mortgage insurance (PMI) on your refinance loan either.
FHA loans vs. conventional loans
Unlike an FHA loan, a conventional loan isn’t backed by the government and requires private mortgage insurance (PMI) to protect the lender when the down payment is less than 20%. FHA loans also require insurance, which is called the mortgage insurance premium (MIP).
However, unlike PMI, you can’t as easily get rid of MIP when you reach 20% equity as you can with a conventional loan. In most cases, you have to refinance your FHA loan to a different type of mortgage to remove MIP.
Here are some of the key differences between FHA and conventional loans.
|Loan limits||Up to $356,362 in most areas, or more for certain high-cost areas.||Up to $548,250 for most areas, or more for certain high-cost areas.|
|Mortgage insurance||MIP is required and cannot be removed without refinancing (for loans originating after 2013).||PMI is required when your down payment (equity) is less than 20%. PMI can be removed when your equity reaches 20%.|
|Credit requirements||500, but most lenders will require a score of at least 580.||Usually 620, but scores of at least 740 can expect the best loan terms.|
- Primary residence
- Single-family homes
- 2 to 4 unit properties
- Some mobile or manufactured homes
- Single-family homes
- 2 to 4 unit properties
- Some mobile or manufactured homes, second homes and rental properties
If you don’t want to pay the closing costs associated with a refinance or lack the documentation to apply for a new loan, an FHA Streamline Refinance may be a good option as a credit and income check isn’t required. To qualify for an FHA Streamline Refinance loan, you must have three months of on-time payments and have had your current loan for at least 210 days. Bear in mind that you still have to pay MIP and a new upfront mortgage insurance fee with an FHA Streamline Refinance.
What is the difference between PMI and MIP?
While they’re similar acronyms, PMI and MIP are different types of mortgage insurance, and which one you pay depends on the type of loan you have.
Here are the key differences.
- PMI. This insurance protects the lender and is required for conventional loans when your down payment is less than 20%. PMI drops off automatically when your home’s equity reaches 20%. You can also cancel it early if you reach 20% equity before the expiration date.
- MIP. This is a type of insurance required for FHA loans, and it doesn’t automatically drop off after you reach 20% equity. For example, if you purchased your home after 2013 and put down less than 10%, you can’t remove the MIP except through refinancing.
Should I refinance my FHA loan to a conventional loan?
Mortgage rates are reaching historic lows, making it an ideal time to refinance. In addition to jumping on the low rate bandwagon, there are other reasons that refinancing an FHA loan to a conventional loan makes a lot of sense and could save you a heap of cash.
You may want to consider refinancing your FHA loan when:
- You’ve reached 20% equity. If you’ve reached 20% equity in your home, you can remove your MIP and PMI payments with a refinance. Not having to pay mortgage insurance can save you thousands of dollars in the long term.
- Interest rates are falling. If you can obtain a lower interest rate than your current rate, refinancing could save you money. Use our mortgage payment calculator to see how much your new payments would be and how much you could save.
- Your credit score has risen. If your credit score has increased since you obtained your FHA loan, you could now qualify for a much better rate based on your improved credit. Even a one- or two-point reduction in interest could save you tens of thousands over your loan’s term.
- You want to get cash out. A refinance can allow you to tap into your home’s equity and get cash out for a range of financial needs, such as paying off higher interest student loans. Mortgage interest is cheaper than student loan interest, making this a potentially smart move for the younger generation.
- You want better terms. Refinancing your FHA loan can help you get better terms, including a lower monthly payment or interest rate. This can help you reign in your budget during more volatile times.
While refinancing can be hugely beneficial, keep in mind that it costs money — anywhere between 2% to 5% of the amount of your refinance loan. It only makes sense to refinance if you plan on staying put long enough to recoup the cost.
Also, you may need to provide your credit and work history to qualify. However, some lenders will waive these requirements, or you can choose an FHA Streamline Refinance and bypass them altogether.
How much could I save by refinancing?
Let’s use an example to illustrate the savings you can gain through a refinance.
Tonia and Jared took out a $360,000, 30-year fixed FHA loan at 6.5%, and they’ve been paying for five years. At this interest rate, their payment works out to $2,275 every month. They’ve also been paying $2,500 a year in MIP.
The couple has now reached 20% equity and found a refinance loan for 4.5%, a 2% reduction in interest. This would reduce their payment to $1,824 – a savings of $5,412 per year or $135,300 over the life of their loan. And because they’ve reached 20% equity in their home, they can remove their MIP payments, allowing them to pocket an extra $2,500 every year.
How to refinance your FHA loan into a conventional
Once you’ve determined that refinancing is right for you and you meet the basic requirements, refinancing an FHA loan is a straightforward process.
Here are the steps to get started:
- Research and compare mortgage lenders.
- Contact the lender or start a loan application online.
- Get your home appraised.
- Close the refinance loan.
- Pay off your FHA loan.
Do I have to stay with my lender?
If you’re considering refinancing your FHA loan, you don’t need to take out a mortgage with your original lender. Rather, you’re free to compare your options and go with the lender that best fits your needs. However, as with any refinance loan, you may be required to meet certain criteria.
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While refinancing a loan involves time and energy, the amount of money you can save can far outweigh the effort involved. A few days spent researching lenders and applying for a refinance loan could save you tens of thousands down the road. To learn more about refinancing, see our mortgage refinancing guide.
Frequently asked questions
What is a refinancing break-even point?
A refinance break-even point is when the savings from your refinance through lower payments exceeds the cost of the refinance.
How do I calculate my refinance break-even point?
To get your refinance break-even point, divide the cost of the refinance by your monthly savings. For example, if a refinance costs $4,500 and the monthly savings from the refinance is $450, the break-even point is 10 months ($4,500/$450=10). After the 10-month mark, you can start pocketing the $450 in monthly savings.
Can I refinance without paying closing costs?
Yes. Some lenders offer mortgage refinancing with no closing costs, but the trade-off may be a higher interest rate. Alternatively, you can refinance your FHA loan using an FHA Streamline Refinance, which has no closing costs. But there is no cash-out option, and you still have to pay MIP and a new upfront mortgage insurance fee.