If you have an FHA loan — a mortgage backed by the Federal Housing Administration — you may want to refinance to reduce your monthly house payment or to achieve other financial goals. Banks and other FHA-approved financial institutions issue these loans, which offer two key perks that appeal to many homebuyers:
— Down payments as low as 3.5%.
— More lenient credit score requirements than most conventional loans.
But FHA loans can be more expensive than conventional loans for some borrowers. Before you start searching for a lender, make sure you understand your FHA refinance options and their requirements.
[Read: Best FHA Loans.]
Can You Refinance an FHA Loan?
Yes, you can refinance your FHA loan, and you can choose from many different FHA refinance options. The key is to select the loan type that makes the most sense for you and check that you meet the qualifications.
How to Refinance an FHA Loan
Homeowners with FHA loans can refinance to either a new FHA loan or a conventional loan, as long as they meet eligibility requirements. The steps to refinance will depend on the lender and the loan you choose.
FHA Refinance Options
FHA streamline refinances are designed to lower your interest rate and monthly payment and allow up to $500 cash back. If you need more money back, you will need to consider a different type of refinance.
The refinancing process is intended to be simple and speedy by limiting paperwork and usually cutting out the home appraisal. Borrowers can choose from credit- or noncredit-qualifying refinances, but both require credit checks. Your lender may not verify your income for a noncredit-qualifying refinance, which could make approval faster.
Keep in mind that an FHA streamline refinance will require you to pay closing costs, and these cannot be wrapped into the new loan. An FHA streamline refinance also does not remove mortgage insurance from your loan.
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 cash-out refinances allow you to take out a loan for more than you owe on your current mortgage, pay off the original loan and then keep the difference. You don’t need an FHA loan for this kind of refinancing, unlike streamline or simple types. You can use the cash for any expense.
FHA 203(k) refinances, also called rehab loans, roll renovation and repair costs into a single mortgage. Borrowers can refinance into an FHA 203(k) limited or standard loan. The difference is that the limited 203(k) loan is for renovations of less than $35,000, and it does not pay for major structural repairs.
The standard loan covers more extensive work, such as additions or full home renovations, and it typically covers jobs that cost more than $35,000. The minimum standard loan amount is $5,000.
Conventional refinances 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.
[Read: Best Mortgage Refinance Lenders.]
What Are the Pros and Cons of Refinancing an FHA Loan?
Get rid of mortgage insurance. All FHA loans come with mortgage insurance. 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 home.
Tap into home equity. An FHA cash-out refinance or 203(k) loan can lower your monthly payment or change your term and give you cash to pay off high-interest debt or to complete home improvements.
Lower your monthly payment. You could save if you’re dropping your mortgage insurance premiums, getting a lower interest rate or financing a smaller principal balance since you closed on your home.
Avoid forbearance. Lower payments may help struggling homeowners who are considering forbearance, which temporarily suspends or reduces mortgage payments.
“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 costs. A lower interest rate could help you save not only on your mortgage payment but also on interest in the long term. Let’s say you refinance a 30-year, $200,000 loan with a 4% fixed interest rate to a new 30-year loan with a 3% fixed rate. Your monthly payment drops by about $112, and this adds up to more than $40,000 in interest savings over the life of the loan.
Change to a different loan type. You can easily refinance from an adjustable-rate mortgage to a fixed-rate loan, or vice versa with an FHA streamline refinance.
You have to pay closing costs. Every time you refinance, you have to pay closing costs on the new home loan. Unless you are sure you will be in the home for a while, those closing costs can negate any savings you get from the refinance.
Your payment could climb. You can pay off your mortgage faster and save on overall interest if you refinance to a shorter term: say, from a 30-year loan to a 15-year loan. But this is only a good idea if you have extra cash to spare for a bigger payment and not a lot of debt.
You could reduce the equity in your home. That’s if you select a cash-out refinance, which converts some of the equity in your home into dollars you can use for any purpose. In addition, the rates for cash-out refinances are often higher than those for other types of refinances.
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 the number of years on your loan term or lower your interest rate — or both.
A streamline refinance makes sense for those who want to lower their interest rate from their current FHA loan.
“Perhaps their credit score at the time of the original FHA loan was low, causing the existing loan to have a relatively higher rate at the time,” says Karen Solgard, a loan consultant with New American Funding.
But you will also need to verify that you have enough cash in a bank account to cover closing costs because they cannot be financed. Some lenders may charge you a higher interest rate and pay the costs for you.
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 will need a minimum credit score of 500, a debt-to-income ratio of no more than 50% and at least 20% equity for this loan.
Be cautious about cashing out your equity, Limón says. Make sure you are clear about how the money will be used. “Once you take out cash from an asset, that devalues your asset,” she says, suggesting that homeowners use the cash only for emergencies or as a way to grow their wealth.
FHA simple refinance: The home you’re refinancing must be your principal residence or a HUD-approved secondary residence to qualify. The lender will order an appraisal and verify that you’ve made on-time payments in the last six months.
FHA 203(k) refinance: This type of loan allows you to refinance and rehabilitate a home that is more than a year old. Only certain types of projects qualify, and they can’t take longer than six months.
[Read: Best Mortgage Lenders.]
Does Refinancing an FHA Loan Make Sense for You?
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 with a refinance. Some people hope to lower their monthly mortgage costs. Others simply want to pay a lower mortgage interest rate or hope to use their home equity to free up cash.
Know what you aim to achieve with a new home loan, and look for the refinance program that would best suit your needs.
Will I qualify for a refinance loan? Lenders may check your credit score, debt-to-income ratio and employment status. Many have adopted stricter standards during the pandemic and favor borrowers with higher credit scores and lower debt-to-income ratios.
Right now, “all borrowers, not just FHA borrowers, will need a better credit score and lower debt than prior to the pandemic,” Solgard says. “Lenders are staring down forbearance requests and possible foreclosures.”
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