If you have an FHA loan — a mortgage backed by the Federal Housing Administration — you might be able to swap your mortgage for a new one at a lower interest rate.
Homeowners refinanced their mortgages in record-breaking numbers throughout 2020, thanks in part to historically low interest rates. And according to a September report from mortgage data firm Black Knight, 18 million homeowners across the U.S. could save money by refinancing.
FHA refinancing may help you lower your monthly payment, borrow cash, or save on other costs like interest and private mortgage insurance. But before you start searching for a lender, you should understand your options and how to qualify for an FHA refinance.
How Does an FHA Refinance Work?
When you refinance, you apply for the mortgage, use the funds to pay off the original loan and then pay down the new mortgage over time.
Homeowners with FHA loans can refinance into either a new FHA loan or a conventional loan, as long as they meet eligibility requirements. In August, 15% of FHA mortgages were refinance loans, according to mortgage software firm Ellie Mae’s Origination Insight Report.
Within the conventional and FHA categories, homeowners have several refinance options to choose from:
— Conventional refinance loans come from private lenders and are not backed by government agencies. Refinancing from an FHA loan into a conventional loan can rid you of mortgage insurance, as long as you have at least 20% equity in the home and can qualify.
— FHA streamline refinances speed up the refinancing process by requiring less paperwork and fewer steps. These refinances are designed to lower your interest rate and monthly payment, with no cash-back option.
— FHA cash-out refinances allow you to take out a loan that’s bigger than your current mortgage, pay off the original loan and pocket the difference. You can use the cash for any expense.
— FHA simple refinances allow homeowners to swap their FHA loans for new FHA loans with either fixed or adjustable interest rates. This refinance has no cash-out option.
— FHA 203(k) refinances, also called rehabilitation loans, “allow you to buy a fixer-upper and bundle the cost of the home and home improvement costs into one loan, saving both time and money,” says Chris Pickrell, regional sales manager at Silverton Mortgage.
What Are the Benefits of Refinancing an FHA Loan?
Homeowners typically refinance to save money, but there are many reasons to refinance:
Lower your monthly payment. If you’ve paid down some of your mortgage since closing on the home, refinancing could lower your monthly payment because the loan is based on a smaller principal balance. When you refinance, you could stretch that smaller balance over more years than you had left on your original loan, making your payment lower. You’ll see further monthly savings if you qualify for a lower interest rate. If you’re looking to shrink your monthly bill, the FHA streamline refinance, FHA simple refinance or conventional loans could help you achieve this goal.
[Read: Best FHA Loans.]
Lower payments may help struggling homeowners who are considering forbearance, which temporarily suspends or reduces mortgage payments. But borrowers must eventually repay those funds.
“It’s more advantageous sometimes for a family to refinance than to go into forbearance,” says Noerena Limón, senior vice president of public policy and industry relations at the National Association of Hispanic Real Estate Professionals. “As long as the monthly payment is reduced, it can help them sustain homeownership.”
Save on interest. Getting a lower interest rate when refinancing could help you save thousands of dollars in the long term.
Let’s say you have a 30-year, $200,000 loan with a 4% fixed mortgage rate and a monthly payment of $955. Within the same year, you refinance into a new 30-year loan with a 3% interest rate. Your monthly payment drops by $112 and adds up to $40,184 in interest savings over the life of the loan.
Get rid of mortgage insurance. All FHA loans come with mortgage insurance in the form of a 1.75% upfront fee, plus an annual mortgage insurance premium of 0.45% to 1.05%. By refinancing an FHA loan into a conventional refinance loan, you can get rid of mortgage insurance — as long as you have at least 20% equity in the home.
Pay off your loan sooner. If quickly paying down debt is important to you, then refinancing into a shorter-term loan can help. While your monthly payments will likely increase because you’re paying off debt within a shorter time frame, you save money and get out of debt sooner.
You can refinance into a shorter term with any of the FHA refinance loans or a conventional loan. But you’ll first need to figure out whether you can afford the higher payment.
Change to a different loan type. You can also refinance from an adjustable-rate mortgage to a fixed-rate loan, or vice versa. With an ARM, your interest rate might start low for a certain number of years and then go up or down for the rest of the loan term.
You can protect yourself from future rate hikes by refinancing with a fixed-rate loan. But changing from a fixed-rate mortgage to an ARM could benefit you if rates are low and you don’t plan to stay in your home for long.
Tap into home equity. Homeowners can also borrow cash using an FHA cash-out refinance or an FHA 203(k) refinance loan. Although you’ll ultimately pay off a larger mortgage balance, you can put the extra money toward other expenses, such as higher-interest debt or home renovations.
“Oftentimes, a cash-out refinance is more economical than taking out personal loans or carrying debt on a credit card,” says Caroline McCarthy, vice president of sales at Own Up, an online mortgage brokering service. “The interest rate on the cash out-refinance can be significantly lower.”
How Can You Qualify for an FHA Refinance Loan?
The eligibility requirements for FHA refinance loans vary depending on the program you choose.
FHA streamline refinance: If you’ve had an FHA loan for at least 210 days and you’ve made on-time mortgage payments in the last six months, then you may qualify for an FHA streamline refinance. These are available for principal residences, U.S. Department of Housing and Urban Development-approved secondary residences or nonowner-occupied properties.
The refinance must result in a “net tangible benefit” to you, which means you reduce your loan term or lower your interest rate — or both. No appraisal is required, which is a benefit if your home value recently dropped.
“A streamline FHA refinance loan is best for borrowers looking to reduce the rate on their current FHA loan, and they don’t believe their home value has increased too much, or they don’t otherwise qualify for conventional financing,” McCarthy says.
You can choose between two types of streamline refinances: credit-qualifying and noncredit-qualifying. With a credit-qualifying refinance, you’ll need a credit score of 580 and a back-end debt-to-income ratio of 43%. This ratio is your total monthly debt expense compared with your gross monthly income.
The lender will also make sure you can continue paying the loan. These requirements don’t apply to noncredit-qualifying FHA streamline refinances, which use your current loan — not your credit rating and income — to qualify you for the loan.
FHA cash-out refinance: You may qualify for a cash-out refinance on a principal residence if you’ve owned the home for at least a year and made on-time payments. You’ll need at least 20% equity, and lenders will either check your employment documentation or utility bills to verify that you occupy the home. While the FHA requires a minimum credit score of 500, lenders may set their own minimum limits.
But be cautious cashing out your equity. Limón recommends being very clear about what that money is going to be used for. “Once you take out cash from an asset, that devalues your asset,” she says, suggesting homeowners use the cash for emergencies or as a way to grow your wealth.
[Read: Best Mortgage Lenders.]
FHA simple refinance: The home you’re refinancing must be your principal residence or a HUD-approved secondary residence to qualify for a simple refinance. The lender will order an appraisal and verify that you’ve made on-time payments in the last six months.
“A simple FHA refinance loan is a good match for borrowers that believe their home value has increased recently,” McCarthy says, “or they want closing costs and prepaid/escrow items to be rolled into the loan to reduce upfront fees.”
FHA 203(k) refinance: The FHA offers two types of FHA 203(k) refinance loans: limited 203(k) and standard 203(k). The standard option has a minimum loan amount of $5,000, and you’ll need to work with a participating lender and a licensed general contractor.
Your home must also meet certain energy-efficiency and structural standards. The limited loan option allows you to borrow up to $35,000 with no minimum cost requirement. Buyers with older homes that need repairs may want to consider this loan, Pickrell says.
How Can You Decide Whether Refinancing an FHA Loan Makes Sense?
If you can cut at least 0.5% to 0.75% off your interest rate, refinancing could make sense.
But it could also be a good move “if you’re looking for a shorter mortgage term, want to make home improvements or would like to have cash on hand for a large expense,” Pickrell says.
Ask yourself these questions to decide whether refinancing is right for you:
What are my financial goals? Think about what you’d like to accomplish and which refinance program would best suit your needs.
If your home value has increased recently and your credit score is higher than when you took out your FHA loan, then refinancing into a conventional loan may help you get rid of mortgage interest costs. Alternatively, you might want to take out cash through an FHA cash-out refinance.
But if your home’s value recently decreased and you’re looking to save money on your mortgage payment, then an FHA streamline refinance might be a good option. No appraisal is required, and the program is meant to save homeowners time and money.
Will I qualify for a refinance loan? Depending on the loan program, lenders might check your credit score, debt-to-income ratio and employment status. Borrowers with higher credit scores and lower debt-to-income ratios are generally seen as less risky — and some lenders have adopted stricter standards during the coronavirus pandemic.
Borrowers approved for FHA refinance loans in August 2020 had an average FICO credit score of 678 and a DTI ratio of 42%, according to Ellie Mae.
Right now, “all borrowers, not just FHA borrowers, will need a better credit score and lower debt than prior to the pandemic,” says Karen Solgard, a loan consultant with New American Funding. “Lenders are staring down forbearance requests and possible foreclosures.”
Refinancing may help you lower costs or find a better type of loan for your situation, but “speak to a mortgage professional about which refinancing option is right for you,” Pickrell adds. “If you fall short of qualifying, a mortgage professional can also help you figure out what actions you can take to better your eligibility in the future.”
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