Many Americans who are buying their first home often rely on FHA mortgages to take part in the American Dream and the thought of quickly refinancing their government insured loan doesn’t usually enter their mind. FHA loans are backed by the US government and as a result, they can be offered by lenders at reasonable interest rates and with low down payments, even if your credit score isn’t the best. It is possible to get an FHA mortgage with only a 580-credit score and a down payment of 3.5%, if you qualify with enough income.
But FHA loans do have down sides. One of them is that you need to pay for mortgage insurance when you close and loan, and annually. You pay the annual mortgage insurance premium as part of your mortgage payment each month.
Another problem with FHA loans today is that you cannot cancel the insurance on the loan if the loan was issued after June 2013, unless you put down 10% or more; in that case, you can cancel the mortgage insurance after paying for 11 years.
While FHA loans are not a bad deal for the first time buyer or someone with past credit problems, it may be better to refinance out of the FHA loan eventually. After all, many people will be paying for mortgage insurance long after they have more than 20% equity in the home. With a conventional mortgage, you can usually cancel mortgage insurance once you have 80% loan to value. It’s important to speak with an experienced loan officer to fully understand the FHA loan requirements.
Why Refinance into a Conventional Loan?
Mortgage rates have continued to rise in 2018, hitting around 4.7% these days. Home values are continuing to go up as the economy is hitting its stride, and there is a shortage of affordable homes. More people are making money and working, so they want to get into the housing market. This demand is causing prices to go up, with annual increases across the country around 7%.
So, if you are enjoying a nice increase in your home’s equity and have more than 20% in the property, it does make a lot of sense to refinance into a conventional loan. You may be able to get rid of mortgage insurance and save yourself at least $100 or more per month.
While conventional loans do have stricter qualification requirements, you can cancel mortgage insurance once you have at least 20% equity in the property.
For that reason, refinancing out of FHA into a conventional loan is usually a good move once you have enough equity. But there are some obstacles to refinancing into a conventional loan for some people.
What Are the Downsides of Refinancing?
First of all, FHA interest rates are higher in 2018 than they have been in recent years. Back in 2017, you could get a 30 year, fixed rate mortgage for less than 4%. Those days are long gone; as noted earlier, 4.7% or so is the norm in June 2018, and many experts think we will see 5% mortgage rates in the next year or less. Today’s rates on FHA home loans remain competitive but they have been rising of late.
While no one wants to pay for mortgage insurance longer than they need to, what if you have a 3.75% rate locked in for the next 25 years? It is hard to justify refinancing into a conventional loan if you are going to be paying over 4.5%.
Also, any time you refinance, you are going to pay closing costs and other fees. SmartAsset says closing costs for a refi can be from 2-5% of the loan total. On a $250,000 loan, you can expect to pay at least $7000 in closing costs. Is this a smart move? It depends if you are going to stay in the house for a long time. If you are going to move in two or three years, you may not save enough money each month with the refinance and no mortgage insurance to break even.
Further, qualifying for a conventional loan is harder than an FHA loan. If you have had any credit problems in the past few years, you could find it harder to qualify. Or you will pay a higher rate than you want.
It also is important to look at what the value of your home is before you really decide to refinance. You want to refinance usually only if you have at least 20% equity in the home and can get rid of mortgage insurance. You may need to pay for a new appraisal to determine what your home is worth in the current market.
Remember when you refinance into a conventional loan, it will be very much like when you got your first loan. You will need to have all of the documents needed to qualify, such as tax returns, pay stubs and bank statements.
If refinancing into a conventional loan is not doable at the moment, you also can do an FHA streamline refinance. While you would still have to pay mortgage insurance, you at least can possibly get into a lower rate. But this is only recommended if you can save about .5% or more on your current rate.