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Refinancing a conventional loan

Weigh the pros and cons of your three main options.

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To determine if refinancing your conventional loan is worth the costs, you’ll need to weigh the fees against your potential future savings. And refinancing isn’t for everyone — make sure your credit is where it needs to be and compare your options before moving forward.

How to refinance a conventional loan

Refinancing your conventional loan starts with shopping around for the lowest rates and fees. Once you find a lender who meets your needs, you’ll then:

  1. Fill out the loan application with your personal information and monthly debt payments, and disclose whether or not you’ve had a bankruptcy or foreclosure.
  2. Once your lender takes a look at your credit score, they’ll ask for copies of financial documents such as W-2s or tax returns, current bank statements and your two most recent pay stubs.
  3. Next, get an appraisal of your home. Your lender will typically put this in motion.
  4. Review the terms and conditions of your loan, paying special attention to the down payment requirement and length of the repayment term.
  5. Explore the option of locking in your interest rate. This will freeze your interest rate for 30 to 60 days or more.
  6. If your lender approves your request to refinance, you’ll get a scheduled date to complete the closing process. Though you’ll have a general idea beforehand, this is when you find out exactly how much your closing costs will be.

Can I refinance a conventional loan?

If you’re looking to lower your monthly payments or you’re trying to pay off your mortgage faster, refinancing your conventional loan is certainly an option. And depending on how your financial needs change over time, you can refinance as many times as you need.
Refinance your conventional loan with one of three options:

Conventional refinance

Borrowers can refinance into another conventional loan and get a new interest rate and loan term.

FHA rate-and-term refinance

Refinance to convert your conventional loan into an FHA loan with a new mortgage rate and loan term.

This could be a good option for borrowers with a less than stellar credit score.

Cash-out refinance

Use your home’s equity to get a loan for more than you owe and take the difference in cash. You can use the lump sum to pay for large expenses like home improvements or to consolidate debt.

Here are the eligibility requirements for each refinancing program:

Conventional refinanceFHA rate-and-term refinanceConventional cash-out refinanceFHA cash-out refinance
Minimum equity3%2.25%20%20%
Maximum LTV97%97.75%80%80%
Minimum credit score620, though 740 or higher is best580620, though lenders prefer 640500, though lenders prefer 580
Maximum DTI36%, but up to 45% with credit score and reserve requirements45%, up to 50% with compensating factors45%, higher with six months reserves43%, higher with compensating factors like a high credit score

Refinancing from a conventional loan to an FHA loan

Borrowers can drop private mortgage insurance (PMI) on conventional loans once they have at least 20% equity in the home. On the other hand, FHA loans require mortgage insurance for the entire loan term. So if you’re refinancing into an FHA loan, you’ll need to weigh the extra costs of mortgage insurance, which is 1.75% of the loan amount.

Whether you’re eyeing a lower interest rate or need to tap into your home equity, make sure refinancing makes financial sense.

When can I refinance my conventional loan?

Lenders set their own policies and terms for refinancing.

While conventional loans don’t typically have a waiting period, most lenders won’t refinance a mortgage that they’ve issued in the last four to six months. If you’re set on refinancing and fall within that time range, you may have to look for a new lender.

FHA rate-and-term refinance loans require you to own the property for 12 months if you have a loan-to-value (LTV) ratio of 97.75%. If you’ve owned the home for less than 12 months, you’ll need an LTV of 85%.

Keep in mind you’ll also need to meet all eligibility requirements. And since closing costs can be expensive, it may not make sense to refinance frequently.

Pros and cons of a conventional loan refinance

There are several benefits and drawbacks to refinancing.

Pros

  • Lower interest rate. If rates have improved since you first took out your loan, you might benefit from refinancing into a lower-rate mortgage.
  • Lower monthly payment. A lower interest rate will result in a lower monthly payment. But make sure to factor in mortgage insurance for an FHA refinance.
  • Cash-out on equity. If you’ve paid down enough of your mortgage, you can tap into the equity in your home.
  • Change the length of your loan. Change from a 30-year term to a 15-year one to pay off your loan sooner, or vice versa.

Cons

  • Possible prepayment penalty. Some lenders charge a prepayment penalty, which can cost you as much as six months of interest payments.
  • New closing costs. Refinancing means a new set of closing costs that average between 2% and 5% of the loan amount. That means to refinance a $200,000 mortgage, you’ll have to bring $4,000 to $10,000 to the closing table.

Bottom Line

Depending on your goals, refinancing your conventional loan can lower your monthly payments or help you pay off your mortgage in less time. But refinancing can cost you 2% to 5% of the loan balance in closing costs. Use our mortgage refinance calculator to see how much you might stand to save.

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