Why You Should Refinance Out of FHA into a Conventional Loan


Refinancing out of an FHA loan into a conventional loan when your loan-to-value ratio reaches 78% allows you to drop mortgage insurance. Having the potential to save you thousands per year.

This article explains the process of refinancing out of an FHA loan, the process, and requirements.

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A Conventional Refinance Allows Homeowners to:

  • Remove mortgage insurance
  • Lower PMI payments
  • Refinance their primary or secondary residence
  • Get a lower interest rate
  • Get cashback using the homes equity
  • Lower monthly mortgage payment
  • Refinance from an adjustable-rate to a fixed rate
  • Shorten the loan term

FHA vs. Conventional Loans

FHA and conventional loans are the two most commonly used types of mortgage loans used in America today. There are several key differences when comparing FHA vs. conventional mortgages. FHA loans are easier to qualify for because they require just a 580 credit score and a 3.5% down payment.

While FHA loans are easier and cheaper to qualify for than conventional loans, they have lower mortgage insurance and allow borrowers to drop their PMI payment once the loan to value ratio reaches 78%. FHA loans require MIP (mortgage insurance premium) for the life of the loan if you put less than a 10% down payment.

FHA Loans

Conventional Loans

Credit Score

500 with 10% down
580 with 3.5% down

620

Down Payment

10% down with 500 score
3.5% down with 580 score

3%-20%

Mortgage Insurance

Up-front MIP payment Monthly MIP payments

>10% down MIP cancels in 11 yrs 
<10% down MIP required for life of the loan

Monthly PMI payments

PMI is canceled when LTV ratio reaches 78%

Loan Limits

Low-cost area - $331,760
High-cost area - $765,600

Low-cost area - $510,400
High-cost area - $765,600

Debt-to-Income

43% - 50% max DTI depending on the lender

Max 43% DTI

Residence Type

Primary residence only

Primary residence
Second home
Vacation home
Investment property

Refinance out of FHA Loans to Remove PMI

You cannot simply get rid of mortgage insurance on an FHA mortgage. To stop paying PMI on an FHA loan, you will need to refinance into a conventional mortgage. If you have paid down the loan to 78% of the home’s value, you can refinance into a conventional mortgage without having to pay PMI.

Conventional PMI rates are lower than FHA

The mortgage insurance fee on a conventional loan is lower than it is with FHA. FHA MIP rates are 0.80% – 1.00%. Many conventional mortgages have an annual PMI fee of 0.50%.

On a $200,000 home, that is savings of almost $80 per month. While it is not a huge saving, the PMI will drop off once the LTV reaches 78%. After dropping PMI, the savings is almost $2,000 per year.

You can generally refinance out of FHA into a conventional mortgage after 6 months.

Refinancing out of an FHA Loan (Pros and Cons)

Pros

  • Lower PMI payments
  • Remove PMI if LTV is under 78%

Cons

  • Required to pay closing costs (1%-5% of the loan amount)
  • More stringent credit and income qualifications

Closing costs

One of the disadvantages of refinancing out of an FHA loan into a conventional loan is the closing costs. Closing costs are fees charged by lenders for originating the loan. The average closing costs are between 1.5% – 3% of the loan amount.

On a $200,000 mortgage, the closing costs can be as high as $6,000. For the refi to make sense, you should be set to save much more than $6,000 on the new mortgage.

Alternative Refinance Options

FHA Streamline Refinance

Refinancing out of an FHA loan doesn’t always make the most sense for some people. If you’re LTV is still pretty high, and you will not be in a position to cancel PMI anytime soon. You can lower your interest rate and monthly payments with an FHA streamline refinance.

Refinancing your FHA loan with a streamline refinance requires less paperwork and is much quicker and requires less paperwork than traditional refinancing. Another advantage of streamline refinancing is that there is no credit check or income verification so if you’re struggling with bad credit, you may still qualify for an FHA streamline refinance.

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