Should I Refinance from an FHA to a Conventional Loan?
If you currently have a government-backed loan – like an FHA loan – you may be thinking that now is a good time to take advantage of low interest rates and refinance to a conventional mortgage. Making the switch can offer many advantages, but keep in mind that just because you want to, doesn’t mean you can — or should — refinance.
Here are a few things to consider.
You may be able to get rid of mortgage insurance
With an FHA loan, borrowers who put down less than 20 percent will pay two kinds of mortgage insurance: a one-time, upfront mortgage insurance premium and a monthly mortgage insurance payment (MIP) that is required for the life of the loan.
On a conventional loan, borrowers who put down less than 20 percent are also charged a monthly fee called private mortgage insurance (PMI). However, PMI can be removed once a borrower hits 80 percent loan-to-value.
“For FHA borrowers who have at least 20 percent equity, refinancing into a conventional loan allows them to potentially eliminate that extra mortgage insurance payment,” said Patty Leonard, senior residential loan officer with Independent Bank. “Your lender will likely order an appraisal to confirm you’ve reached that threshold, but if so, dropping mortgage insurance, as well as possibly taking advantage of a lower interest rate, could save you a significant amount of money.”
But what if you haven’t quite hit that 20 percent mark? Leonard says it may still be worth refinancing into a conventional loan.
“Even if you pay PMI, the advantage is that it will eventually drop off, which isn’t possible with an FHA loan,” she said. “But like with any transaction, we need to run the numbers to make sure it’s a smart financial move.”
But you still need to qualify
A big difference between FHA loans and conventional programs are the qualifying guidelines. One of the reasons borrowers are drawn to FHA loans, is that they allow for lower credit scores.
According to the FHA website, borrowers need at least a 580 to qualify for a loan using a 3.5 percent down payment. Borrowers with scores as low at 500 can still qualify with a down payment of 10 percent.
To qualify for a conventional loan, you’ll typically need a credit score of at least 620. Borrowers with scores of 740 or higher tend to get the most attractive conventional loan rates. So, if you’ve been working to improve your credit score over the years, you may now be able to qualify for a conventional mortgage and potentially secure a lower interest rate.
But, if you don’t have 20 percent equity and will be paying PMI, keep in mind that your credit score is a factor in determining that amount.
“With an FHA loan, mortgage insurance is a flat rate,” explains Leonard. “But on a conventional loan, the lower your credit score, the higher your monthly PMI premium. Your credit score may allow you to qualify for a conventional loan, but if it’s on the lower end, you may pay more in PMI and potentially have a bit higher interest rate.”
Something else to consider
Keep in mind that refinancing comes with closing costs that will need to be paid at closing or rolled into the loan. As a basic example, if you pay $4,000 in closing fees to refinance and save $200 a month on your mortgage, it will take you 20 months to break even. If you sell your home in the next 1 to 1.5 years, refinancing probably wouldn’t be the best option.
Leonard says that due to historically low interest rates, her business has doubled in 2020. But even though it’s a great time for many homeowners to refinance, it’s not the right answer for everyone, and Leonard is upfront with her clients about that.
“I met with a homeowner the other day who was interested in refinancing but was planning to sell within the next two years,” she said. “We ran the numbers and it just didn’t make financial sense. We could have gone through with the deal, and he would have lowered his monthly payment, but in the end, he would lose money on the transaction. A reputable lender will ask the right questions and will be honest with you, putting your best interests above the desire to close a deal.”
For a list of professional area lenders, visit the Greater Lansing Association of REALTORS® website at www.lansing-realestate.com.