Refinancing Your FHA Loan to a Conventional Loan

If you’re like many American homeowners, your first mortgage may have been a loan with the Federal Housing Administration (FHA). Loans backed by the FHA are attractive to first-time homebuyers because FHA loans can be easier to obtain financing for and require minimal down payments and fair-to-good credit scores.

On the other hand, FHA loans require certain provisions that can sometimes affect the homeowner's budget such as ongoing monthly mortgage insurance requirements. If you’re in this situation, you may want to consider refinancing your FHA loan into a conventional mortgage.

Let’s look at what refinancing an FHA loan to a conventional loan entails, the differences between the two types of mortgages and the factors to consider before making a decision.

Conventional Loan Differences

As you begin to explore financing an FHA to a conventional loan, it’s important to understand the most significant differences between the two.

FHA Loans

• More lenient credit score requirements than conventional loans
• Lower down payment requirements than conventional loans
• Require an upfront mortgage insurance premium (which can be financed into the loan) and ongoing monthly MIP (mortgage insurance premium), which is typically paid for the first 11 years or life of the loan, depending on how much equity you have
• Insured by the FHA (Federal Housing Administration)

Conventional Loans

• More stringent credit score requirements than FHA loans
• Mortgage insurance only required if the down payment is lower than 20%
  • Cancellation can be requested once 20% equity is met, based on the original appraised value of the home
• Higher loan limits than FHA loans

FHA Loans and Mortgage Insurance Premiums

While there are several differences between FHA and conventional loans, one of the most notable is the mortgage insurance requirement.

If you have an FHA loan, you’re likely aware that this loan stipulates that borrowers pay two kinds of mortgage insurance:

• A one-time, upfront mortgage insurance premium (UFMIP) that is paid at closing. Today, the UFMIP costs roughly 1.75% of a loan’s principal balance. For example, borrowers applying for a $200,000 30-year fixed FHA loan must pay a $3,500 UFMIP. Keep in mind that this can also be easily financed into the loan which is what many homeowners choose to do.
• A monthly mortgage insurance payment (MIP). This is generally required for the first 11 years or life of the loan, depending on the down payment at the time of purchase or equity in the home for a refinance. The MIP is calculated at 0.45% to 1.05% of the loan balance throughout the term of an FHA loan. These premiums can add anywhere from $100 to $500 to the monthly payment.

Can You Refinance an FHA Loan to a Conventional Loan?

The answer to that question depends on certain eligibility factors.

You can refinance an FHA loan to a conventional loan, but you’ll need to meet minimum requirements. If you don’t meet the equity minimum for a conventional loan, you’ll need to account for continued PMI costs until you’ve reached at least an 80% loan-to-value ratio (or lower).

The Pros and Cons of Refinancing Your FHA Loan to a Conventional Loan

Having explored the differences between FHA and conventional loans, let's now examine the advantages and disadvantages of refinancing from an FHA to a conventional loan.

Pros

Eliminate Mortgage Insurance: If you have built at least 20% equity in your home at the time of refinancing, you may be able to eliminate the mortgage insurance requirement altogether. This may be the case if your home's value has increased or you’ve paid down the principal balance sufficiently.

Haven’t yet met the equity threshold? You have the right to request the cancellation of your mortgage insurance once you do. Additionally, your lender is required by the Homeowners Protection Act of 1998 to automatically cancel mortgage insurance when the loan-to-value ratio reaches 78% based on the original amortization schedule, provided you’re current on your payments.

Reduce Long-Term Costs:* Without the burden of ongoing mortgage insurance premiums (after reaching 20% equity), you may significantly reduce the total cost of your loan over time.

Take Out Larger Home Loan: Conventional loans generally have higher limits than FHA loans, so you can borrow more.

Equity Building: Without mortgage insurance payments and potentially lower interest rates, homeowners can build equity in their property faster, providing more financial flexibility in the future.

Cons

Potential Mortgage Insurance Costs: If you don’t currently meet the equity requirements, you’ll need to account for continued PMI costs until you reach that magic number of 78%, and in some cases, 80%, in loan-to-value ratio.

Mortgage Insurance Mandate. While FHA loans offer lower interest rates than conventional loans, you’ll be required to pay mortgage insurance.

Requirements for FHA to Conventional Loan Refinance

To refinance from an FHA to a conventional mortgage, you’ll need to present a few documents to prove your borrowing worthiness, such as:

• Pay stubs
• Tax returns and W-2s and/or 1099s
• Your credit report
• Asset statements

You will be required to present income documentation. In some cases, a full appraisal may not be required.

Another Refinancing Option: FHA Streamline Refinance

The FHA Streamline Refinancing program provides homeowners with another way to refinance. If you’re looking for ways to lower your monthly mortgage payments or hoping to convert an adjustable-rate mortgage into a fixed loan, you could benefit from an FHA Streamline Refinance. This loan can even help homeowners whose mortgages are considered ‘underwater,’ meaning the property's current market value is less than the amount owed on the mortgage. In fact, the FHA Streamline program was put in place specifically to reduce loan defaults.

To qualify for a FHA Streamline Refinance, you must meet the following requirements:

• You must already have an FHA-backed mortgage
• All mortgage payments must be current
• You must have made at least 6 payments on the FHA mortgage that is being refinanced, at least 6 full months must have passed since the first payment due date of the mortgage that is being refinanced and at least 210 days must have passed from the closing date of the mortgage that is being refinanced
• Disbursed cash out to the borrower cannot exceed $500

Keep in mind that lenders may have their own specific requirements in addition to the above. It’s also important to note that streamline refinancing does carry the requirement for mortgage insurance, though UFMIPs are typically absorbed in the mortgage and are not paid in cash.

Understanding FHA Streamline's Net Tangible Benefit Requirement

FHA Streamline Refinancing lenders must demonstrate a valid reason for refinancing, which is determined by something called the Net Tangible Benefit. A Net Tangible Benefit is a:

• Reduced combined rate of the principal and interest (P & I) of the mortgage payment, plus the annual MIP
• A change from an ARM to a fixed-rate mortgage
• A reduced term that results in a financial benefit to the borrower

Is Now a Good Time to Refinance My FHA Loan to a Conventional Mortgage?

If you’re still unsure whether you should refinance from an FHA loan into a conventional mortgage, answer the following questions to help you decide if it’s the right move.

1. What are my goals?

If you’re looking to lower your monthly payments or switch from an ARM to a fixed-rate loan, going into a conventional mortgage might be right for you. You may also be eligible to take advantage of a cash-out refinancing option.

2. Does refinancing make financial sense?

If current interest rates are higher than your existing rate or if the difference is negligible, refinancing into a conventional loan may not be worth the cost. You can use a loan calculator to estimate your monthly payments.

3. What is the current value of my home?

Most home values have risen over the years, giving homeowners more equity and making refinancing into a conventional mortgage an attractive option for homeowners. If you owe more on your mortgage than your home is worth, you may still be eligible for an FHA Streamline.

4. What is my home equity?

If you have more than 20% equity in your home, converting from an FHA into a conventional home loan makes a lot of sense. However, even if you don’t have 20% equity, refinancing into a conventional loan can still be a good option. In most cases, you can take advantage of a much lower monthly mortgage insurance premium and still lower your rate

5. Can I afford refinancing closing costs and fees?

There are closing costs and fees involved with refinancing. With an FHA Streamline Refinance you’re required to pay these costs at closing. They cannot be rolled into your loan. With a conventional loan, you may be able to roll those costs into your new loan. Use our mortgage refinancing calculator to understand how financing these fees could impact your monthly payment.

6. Can I provide all of the necessary documentation?

Refinancing into a conventional mortgage is similar to your initial home-buying experience. It requires a compilation of documents, such as tax returns, pay stubs, W-2s or 1099s and your credit report. If you have a lower credit score or recently blemished credit, a FHA Streamline is a great option.

Considering a Refi? Talk to a Pennymac Loan Expert

Wondering if refinancing from an FHA to a conventional loan is right for you? A licensed loan officer can help you evaluate the nuances of FHA refinances and help you identify your best financial solution. To see if a conventional loan refinance makes sense, speak with a Pennymac Loan Expert or apply online today.

*By refinancing your existing loan, your total finance charges may be higher over the life of the loan.

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