How To Refinance FHA To Conventional Loan: A Guide
If your first mortgage was an FHA loan, and you’re tired of paying FHA mortgage insurance premiums, you might be a good candidate to refinance an FHA to a conventional loan. Some homeowners save quite a bit with this refinance, especially if they can get a conventional loan with no mortgage insurance.
Can You Refinance A FHA Loan To A Conventional Loan?
Many borrowers choose to refinance an FHA loan to conventional to eliminate the required mortgage insurance on FHA loans. Borrowers who chose an FHA loan when they bought their home usually do so because they have a lower credit score, higher debt-to-income ratio, or insufficient funds for a 5% down payment.
FHA loans have more flexible underwriting guidelines, making it easier to qualify for financing, but once a borrower improves their financial situation, a conventional loan may be an option.
How Soon Can I Refinance FHA Loan To Conventional Loan?
Most conventional loans are conforming loans. This means they meet Fannie Mae and Freddie Mac's guidelines. Since Fannie Mae and Freddie Mac don’t require a waiting period for rate-and-term refinances, you can refinance from an FHA loan to a conventional loan when you meet the qualifying requirements. However, if you want to tap into the home equity with cash-out refinance, you may have to wait 6 months, along with having enough equity in your home.
What Are The Requirements To Refinance To A Conventional Loan?
You must meet the conventional loan requirements to take advantage of an FHA to conventional refinance. However, they aren’t as challenging to meet as most people assume.
Here’s what’s required:
- 620 minimum credit score: Check your credit score to ensure you have at least a 620 to qualify for a conventional loan. But, the higher your credit score, the better terms you’ll get when refinancing.
- 43% or lower debt-to-income ratio (DTI): Your debt-to-income ratio measures your monthly debts to your gross monthly income. Conventional loans allow a DTI of up to 43%, but like your credit score, the better your DTI is, the better terms you’ll get.
- 3% – 5% home equity: The more equity you have, the better, but as long as you have at least 3% – 5% equity, you might qualify for a conventional loan. This is because you earn equity when your home appreciates and when you make your regular monthly payments.
- Proof of home’s value: You’ll pay for a new appraisal when refinancing FHA to conventional. Lenders must have evidence of the home’s value to ensure you have at least 3% – 5% equity in the house.
- No other outstanding liens: Your title must not show any other outstanding property liens, such as unpaid taxes, mechanic’s liens or other mortgage loans. However, there is an exception if you have a second mortgage and the lender is willing to subordinate the debt to the new conventional loan.
Reasons To Do An FHA-To-Conventional Loan Refinance
Refinancing from FHA to conventional isn’t for everyone, but here are the most common reasons borrowers consider it.
Cancel Mortgage Insurance
The most significant reason borrowers refinance FHA loan to conventional is to eliminate mortgage insurance. The FHA mortgage insurance premium is an insurance policy you pay for, but it protects the lender if you stop making payments. All borrowers must pay MIP regardless of their down payment.
Here’s how it works:
- If you put down at least 10% on the home, you pay an upfront MIP and an ongoing MIP for 11 years
- If you put down less than 10% on the house, you pay an upfront MIP and an ongoing MIP for the life of the loan
Conventional loans also have mortgage insurance called private mortgage insurance or PMI. The difference is that each borrower pays a different amount based on their credit score and the loan-to-value ratio. The less money you put down, the more PMI you pay.
However, homeowners can request that PMI be canceled once they owe less than 80% of the home’s original appraised value. For example, if the homeowner made on-time payments and there aren’t any issues with the loan, most lenders will cancel PMI at 80%.
If homeowners don’t request PMI cancelation, the lender must automatically cancel it once the borrower has 22% home equity or a 78% loan-to-value ratio on the home’s original appraised value.
However, if a borrower already has 20% equity in the home, they can refinance an FHA loan to conventional and eliminate mortgage insurance.
Lock In A Lower Interest Rate
Borrowers often refinance into a conventional loan to take advantage of lower interest rates. Timing the refinance from an FHA loan to a conventional loan when rates are lower than they currently pay can save them money.
This works best when borrowers also improve their credit score since lenders base the interest rates charged on a borrower’s credit.
Here’s an example of how lowering a mortgage rate can save a borrower money.
Jack has a $255,000 loan at 5.1%. His monthly principal and interest payment is $1,384.52, and if he keeps the loan for 30 years, he’ll pay $243,427 in interest.
If Jack refinances his loan after 10 years, he will still owe around $208,000. Say he refinances at 4.5%
Cash Out Your Home Equity
Another reason to refinance FHA to conventional is to tap into a home’s equity. For example, a cash-out refinance can help homeowners with home repairs or renovations, pay off debt, or invest in retirement or college savings.
Homeowners need at least 20% equity left untouched, so this works only when they have a significant amount of equity in the home. While there is an FHA cash-out refinance option, the added MIP expense often makes it unaffordable.
Conventional loans don’t require PMI on cash-out refinance loans because homeowners can’t borrow more than 80% of the home’s value.
Cons Of Refinancing From An FHA To Conventional Loan
Like any refinance option, there are downsides to refinancing from FHA to conventional. Understanding these downsides can help you make the right decision for your home.
You Have To Cover Closing Costs – Again
Each time you refinance, you must pay closing costs. Since closing costs average 2% – 6% of the loan amount, the costs can add up quickly. Therefore, before you refinance, determine if the benefits outweigh the cost.
The key is determining how long you’ll be in the home and what you’ll do with the money, especially for a cash-out refinance. Do you have other ways to access cheaper funds, or does refinancing your home make the most sense?
You Repeat The Loan Approval Process
Repeating the loan approval process isn’t welcome news to any borrower. While lenders, such as Rocket Mortgage, make the loan approval process as easy as possible, there’s still the time commitment and the hassle of gathering your financial documentation to prove you can afford the loan.
For example, you must gather the following documents to refinance:
- Tax returns (for the self-employed)
- Recent pay stubs
- Bank statements
- Verification of homeowners insurance
- Verification of employment
You may also have to pay for another home appraisal to prove your home is worth enough for the refinance.
You May Still Pay Mortgage Insurance
There’s still the chance that you’ll have to pay mortgage insurance. If you borrow more than 80% of the home’s value, you’ll pay PMI until you hit the 80% threshold. You can cancel PMI when you’ve paid your balance down to 80%, but the bad news is that you might still pay mortgage insurance.
Alternatives To An FHA-To-Conventional Refinance
Homeowners that don’t qualify for an FHA to conventional refinance can try the FHA Streamline Refinance. This program is still an FHA loan, but borrowers don’t have to verify much to get approved.
To qualify for the FHA Streamline Refinance, borrowers must:
- Have a current FHA loan
- Not have any delinquent payments in the last 12 months
- Prove there is a net tangible benefit for refinancing
The Bottom Line
Many homeowners can refinance FHA to conventional loans at some point in their homeownership. However, before you refinance, make sure it makes financial sense to start your term over and pay closing costs.
If it makes sense and you’d like to explore your options, start a mortgage application today to speak with a Home Loan Expert and get advice on the best refinancing options for your situation.