Refinancing a mortgage loan can give homeowners financial benefits, so it is always a good idea to explore this option. However, it can be complicated. Can you refinance the FHA loan to conventional? What does the process require? Do you need any specific documents? Will your payments increase? What are the benefits? What is the right time?

Well, we are here to answer some questions!

Can You Refinance the FHA Loan to Conventional Loan?

A lot of people buying a home for the first time may go for FHA loans since it doesn’t have strict down payment needs. However, the FHA needs borrowers to get a Mortgage Insurance Premium (MIP). The MIP is a one-time cost that is 1.75% of the value of the loan. You also have to pay the annual premium that’s part of the loan.

If you refinance from a FHA loan to conventional type, you won’t have to pay the mortgage insurance. As long as the home equity is above 20%, you can choose this option. It could mean big savings and lower monthly costs for you. Plus, you can save the amount you spent on insurance towards other costs.

Pros and Cons of Refinance FHA Loan to Conventional Loan

There are some advantages and disadvantages that you should consider carefully before applying for refinancing. Everything has some good and bad, but they should line up with your needs!

Let’s take a look now.

Pros

Eliminating or Reducing Mortgage Insurance

You have to pay the MIP for the entire life of an FHA loan. This is only applicable for people who paid less than 10% of the down payment at the start of their loan.

You will have to pay mortgage premiums even when you have paid off 80% of the home’s value. Of course, all of these payments add to the overall cost you bear.

When you go for refinancing and switch your FHA loan to a conventional loan, you can eliminate the mortgage insurance. This is possible as long as the loan-to-value (LTV) ratio is a minimum of 80%. You can also reduce them for now and remove them in the future depending on the LTV.

Increase Loan Size

In 2021, the FHA raised the minimum loan limits for single-family homes to $548,250. Hence, you can try refinancing to get a loan that is at least 5% higher than the unpaid balance on your existing loan.

By taking out a larger loan, you can use the extra cash to make improvements or renovations around the house. You can also pay off other debts with the money. Some may even wish to pre-pay the mortgage but be vary of lender limits and penalties on prepayments.

Change or Reduce Interest Rates

The best part of refinancing options is the likelihood of decreasing your interest rate. If you apply for refinancing when interest rates are falling, you can get a great rate. This will significantly impact your savings every month and what you pay overall over the loan’s life.

People with adjustable loan rates can also choose to switch to fixed rate payments. This can help you better plan for the month's budget.

Reduce Monthly Payments

Refinancing means that you are getting rid of the old loan and replacing it with a new one. This means you can get new terms on how much you are paying monthly. For example, if you have switched from a 15-year term to a 30-year term, your monthly payments will drop.

Plus, eliminating or reducing your mortgage premium payments can also bring down your monthly and annual costs.

Cons

Closing Cost Payments (Again)

Since your old mortgage agreement is being switched to a new one, you will have additional closing costs to take on. You are essentially going through the process of getting a mortgage once more.

For many, the closing costs can be so high that they end up eating up any savings they might have made from lower interest rates or no mortgage insurance. Hence, it is important to properly calculate closing costs to make sure it’s even worth it.

You can do the math for when you will be able to recoup the costs, known as the break-even point. It probably doesn’t make sense to try refinancing if your break-even point is in three years and you don’t plan on staying in the home for that long.

Here are some potential costs that you should look at for refinancing:

● Credit check fees
● Origination fees
● Appraisal fees
● Title search charges
● Insurance charges
● Prepayment penalties
● Attorney fees
● Recording fees

Plenty of Paperwork

You probably remember the amount of paperwork you had to do when you first applied for the mortgage. Well, you will probably have to do it all again. You will need important documents, such as assets, employment history, proof of income, etc. for the refinancing application.

Slight Dip in Credit Score

Every time your credit history faces a hard inquiry, it will impact the overall credit score. This is temporary, of course. Your lender will evaluate your creditworthiness and risk by running a solid credit check, so be prepared.

What Is the Right Time to Refinance a Mortgage?

Refinancing is only a good option when it makes financial sense to do so. If you want to save money through the refinancing process, you should as long as you are planning to stay beyond the break-even point.

Another great time to try refinancing is when interest rates are trending low. If the interest rates are falling beyond the mark when you first applied for the mortgage, refinancing can be a good option. It can lead to many savings for you monthly as well as throughout the life of the loan.

For people who recently got married or divorced, refinancing can make sense. For newlyweds, it can offer lower interest rates since you seem like a less risky investment to lenders. For divorcees, it can help divide assets or remove someone from the title deed.

If your credit score has improved over time or your debt-to-income ratio has gone down, refinancing can help you get better loan terms. People with a credit score of at least 780 will receive some of the best interest loan rates.

Refinancing is also a good idea if the value of your home has increased recently. When your home equity is higher, you can try cash-out refinancing options to get a nice windfall. Plus, it’s also a viable option if you have recently come into an inheritance or extra funds.

Conclusion

So, can you refinance FHA loans to conventional loans? Yes, it can actually be a great idea if the time is right for you. Keep the closing costs and break-even point in mind when you make a decision.