FHA loans are a great mortgage program.
The low credit and down payment requirements reduce the barrier to entry for home loans.
But there comes a time when refinancing out of an FHA loan is a good idea.
Here are the reasons why you should refinance your mortgage from an FHA loan to a conventional loan.
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A Conventional Refinance Allows Homeowners to:
1. Remove mortgage insurance
2. Lower PMI payments
3. Refinance their primary or secondary residence
4. Get a lower interest rate
5. Get cash back using the homes equity
6. Lower monthly mortgage payment
7. Refinance from an adjustable rate to a fixed rate
8. Shorten the loan term
FHA vs Conventional Loans
FHA and conventional loans are the top 2 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. Much lower than conventional loans which typically require a 640 credit score and 10% – 20% down.
While FHA loans are easier and cheaper to qualify for than conventional loans. Conventional loans have lower mortgage insurance and allow a borrower 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. Even if you have 10% or more down, you will pay MIP for 13 years.
MIP vs PMI
MIP and PMI are both terms describing mortgage insurance. MIP stands for mortgage insurance premium on FHA loans. PMI stands for private mortgage insurance on conventional loans.
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 value of the home 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 os 0.50%.
On a $200,000 home that is savings of almost $80 per month. While it is not a huge savings, 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)
- Lower PMI payments
- Remove PMI if LTV is under 78%
- Required to pay closing costs (1%-5% of the loan amount)
- More stringent credit and income qualifications
One of the disadvantages of refinancing out of a FHA loan into a conventional loan are 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. In order for the refi to make sense you should be set to save much more than $6,000 on the new mortgage.
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.
Streamline refinances require less paperwork and are much easier than traditional refinancing. Another advantage of the streamline refinance is that there is no credit check or income verification. If you are struggling with bad credit you may still qualify for a FHA streamline refinance.
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