If you have a Federal Housing Administration (FHA) loan but aren’t completely happy with it, there’s good news: You’re not stuck with it. Instead, you can shop around for mortgages with better terms or rates, then apply for a refinance. To get started, brush up on how FHA refinancing works so that you can find the best option available.
- Consider refinancing with one of four FHA programs or a conventional loan.
- In addition to getting new loan terms, you can also apply to cash out some of your equity.
- In some cases, refinancing an FHA loan must result in a tangible benefit.
- Compare the benefits of refinancing with the additional expenses, such as closing costs.
FHA Refinancing Explained
Refinancing an FHA loan – a mortgage that is backed by the U.S. Department of Housing and Urban Development (HUD) – involves getting a new mortgage to replace your old one; the old mortgage is then paid off by the new lender. You could qualify for different loan terms, such as a lower interest rate or a different payoff term; you could also qualify for a new loan amount, resulting from either paying down a portion of the remaining balance or borrowing from your home equity.
There are closing costs involved with FHA refinancing, which could amount to anywhere from 2% to 6% of your loan balance. Because of those built-in expenses, you need to figure out if a refinance makes financial sense.
Reasons To Refinance Your FHA Loan
There are several scenarios in which you could lower your monthly payment by refinancing your FHA loan, but FHA refinancing isn’t always just about saving money. Consider all the reasons you may benefit:
- You want a lower interest rate. If rates have dropped since you bought your home or your credit score has substantially improved, refinancing could help you pay less interest over time.
- You want to drop your mortgage insurance premium. FHA loans come with both an upfront and an annual mortgage insurance premium (MIP). If your down payment was less than 10%, you can only get rid of mortgage insurance by paying off your FHA loan or refinancing to a conventional mortgage. If your down payment was 10% or more, your MIP will last 11 years. Either way, refinancing to a different type of mortgage can help you lower or get rid of this cost.
- You want to cash out equity. If you have enough equity and qualify for a larger mortgage amount, you can do a cash-out refinance. You get to keep the difference between the old loan balance and the newer, larger mortgage.
- You want to change your loan term. You can either shorten or lengthen your loan term. Switching to a 15-year loan term, for instance, could help you qualify for a lower rate and pay off your home faster. Lengthening your term often costs more in interest over time, but could lower your monthly payment.
- You want to remove a borrower. Refinancing gives you the opportunity to remove a co-borrower from the loan, as long as you can qualify for the new mortgage on your own.
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FHA Refinancing Options
There are several ways you can refinance your FHA loan, depending on your goals and eligibility.
FHA Simple Refinance
An FHA simple refinance offers a rate-and-term switch for homeowners who already have an FHA loan. That means you get another FHA loan with a new interest rate and term length, but you can’t cash out any equity. You can also use this refinancing option to remove a co-borrower from the loan.
Eligibility requirements
- Minimum credit score of 580
- Up to date on the last 6 months of payments
- No more than one payment made 30 days late or more
- Home appraisal required
- Minimum 2.25% equity required for the new loan amount
Costs to consider: Closing costs apply, but they can be rolled into the loan if you qualify. You’ll also still need to pay upfront and annual mortgage insurance premiums.
FHA Streamline Refinance
An FHA streamline refinance is also designed to update your rate and term on an existing FHA mortgage, but requires less documentation during the application process compared to other options. Plus, there is no appraisal needed and no loan-to-value limits. You do, however, need to show that there is a net tangible benefit for you as the borrower, either through a rate or term reduction, that yields a certain percentage net benefit to the consumer overall.
Eligibility requirements
- No credit check required
- At least 6 months since your first payment due date
- At least 210 days since your original closing date
- Must qualify for a lower rate or term
- Original mortgage must be current
- Up-to-date on last 6 months of payments
- No more than one payment made 30 days late or more
Costs to consider: Your interest rate may be higher if you choose not to submit income and credit documentation. Closing costs apply, but some lenders offer to cover these upfront costs in exchange for a higher rate. Since it’s still an FHA loan, you’ll also have to pay upfront and annual mortgage insurance premiums.
FHA Cash-Out Refinance
An FHA cash-out refinance lets you apply for a larger loan amount than your current balance and receive the difference as cash. You can then use that money for some of your larger financial goals, such as home improvements, debt payments or college tuition.
In order to qualify, you need to meet the debt-to-income (DTI) ratio requirements for a larger loan amount, since your new balance will be higher. Unlike the previous two options, you can apply for an FHA cash-out refinance with either an existing FHA or conventional loan.
Eligibility requirements
- Must keep at least 20% home equity
- Minimum credit score of 580
- Debt-to-income ratio of 43% or less (With exceptions to this rule in certain instances)
- Must have lived in your home for at least 12 months
- No late payments over the last 12 months
- Home appraisal required
Costs to consider: In addition to closing costs, expect to pay a mortgage insurance premium, both up front and annually. Keep in mind that a cash-out refinance also results in more interest paid over time, since you’re borrowing more money.
FHA 203(k) Refinance
You can use an FHA 203(k) loan to refinance an existing mortgage and borrow additional funds to put toward a rehabilitation project on your home. Once the original mortgage is paid off, any leftover money is put in an escrow account until the rehab project is finished.
You can borrow up to $75,000 for minor repairs with a limited 203(k) loan, or opt for a standard 203(k) to use on major repairs. There’s no upper limit with the latter option, but you do need to spend at least $5,000. A bonus: An FHA 203(k) refinance is available to homeowners with any kind of existing mortgage, not just an FHA loan.
Eligibility requirements
- Funds must be used for eligible improvements
- May need to work with an FHA-approved 203(k) consultant
- Must use licensed contractors
- Renovations must be completed in 9 months (for Limited) and 12 months (for Standard)
- Up to 20% contingency reserve is required
- Typically requires a minimum 580 credit score and a debt-to-income ratio of 43% or less
- 3.5% home equity required
Costs to consider: You’ll need to pay standard closing costs, and any equity left from paying off your original loan will be tied up in escrow until repairs are complete. On top of that, you may need to keep up to 20% of the estimated repair costs in reserve as a contingency in case expenses run higher than expected.
Conventional Loan Refinance
A final option for FHA refinancing is to switch to a conventional loan. If you have at least 20% equity in your home, you can avoid paying private mortgage insurance (PMI). Otherwise, you’ll have this fee included in your monthly payment until you reach 20% equity. You could also consider a cash-out refinance with a conventional loan.
Typical eligibility requirements
- Typically a minimum credit score of 620
- Debt-to-income ratio of 50% or less
- Appraisal required
Costs to consider: Closing costs average anywhere between 2% and 6% of the new loan amount. On top of that, you have to pay PMI each month if your equity is below 20%.
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How To Apply For An FHA Refinance
Once you’ve chosen the type of mortgage you want for your refinance, follow these five steps:
- Gather quotes: Compare loan quotes from multiple lenders to see what interest rates and other terms you qualify for.
- Submit your application: In addition to filling out personal and financial information, you’ll also need to submit documentation to support your application. Lenders often require recent pay stubs, W-2s and bank statements. They may also ask to see 1099s and profit-and-loss statements if you’re self-employed.
- Go through underwriting: This is the lender’s verification process. They typically confirm your income and assets and run a credit check.
- Get your home appraised: An appraiser must visit your home to confirm its fair market value. Your new loan amount can’t be higher than the appraised value, so this step could impact how much equity you can access with a cash-out refinance.
- Close on your new mortgage: Once your loan is approved by the underwriter, you’re in the home stretch – it’s time to review disclosure statements. You should receive these from your lender at least 3 days prior to your closing date. At closing, you’ll sign all the final documents and pay your closing costs.
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The Bottom Line: Refinancing An FHA Loan Could Lower Your Interest Rate And Costs
FHA refinancing has the potential to provide you with plenty of benefits, such as lowering your interest rate or helping you shed your mortgage insurance premium. Explore all of the available options to make sure that you pursue a refinance that would offer the biggest financial impact compared to all of the costs involved.
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Ben Shapiro
Ben Shapiro is an award-winning financial analyst with nearly a decade of experience working in corporate finance in big banks, small-to-medium-size businesses, and mortgage finance. His expertise includes strategic application of macroeconomic analysis, financial data analysis, financial forecasting and strategic scenario planning. For the past four years, he has focused on the mortgage industry, applying economics to forecasting and strategic decision-making at Quicken Loans. Ben earned a bachelor’s degree in business with a minor in economics from California State University, Northridge, graduating cum laude and with honors. He also served as an officer in an allied military for five years, responsible for the welfare of 300 soldiers and eight direct reports before age 25.
