Can You Refinance an FHA Loan?

If you currently have an FHA loan and are wondering if you can refinance it, the answer is yes. FHA loans are eligible for refinancing just like conventional loans are.

Depending on prevailing interest rates, refinancing an FHA loan can be a good way to lower your monthly payment, shorten the mortgage term to get yourself to the finish line sooner and save big money on accumulated interest, or even get cash out by leveraging home equity.

In this guide we take a closer look at how to refinance an FHA loan and what you need to know before you start searching.

What Is an FHA Loan?

First, let's define what an FHA loan is. An FHA loan is a mortgage that is insured by the Federal Housing Administration (FHA). These loans are popular with first-time homebuyers and those who may not have the credit or down payment to qualify for a conventional loan. The FHA loan program was created in 1934 as a way to help more Americans become homeowners.

An FHA loan has some unique features that make it different from a conventional loan. For example, FHA loans typically permit a lower down payment, as little as 3.5% of the purchase price of the home. This can be a big help for first-time homebuyers who may not have saved up a large down payment. FHA loans also have lower credit score requirements, making it easier for borrowers with so-so credit to qualify.

Related: Tips to improve your finances before a refinance

When Can You Refinance an FHA Loan?

You can refinance an FHA loan at any time as long as you meet the requirements set by the Federal Housing Administration. However, there are some restrictions that you need to keep in mind.

Firstly, you need to have made at least six payments on your existing FHA loan and have owned the property for at least 210 days before you can refinance. Additionally, you will need to have a credit score of 500-plus to be eligible for an FHA loan refinance, and you must be current on your mortgage payments.

The FHA offers several refinancing options, including a traditional rate and term refinance, a cash-out refinance, and a streamlined refinance. The eligibility requirements for each of these refinancing options may vary, so it's important to consult with a mortgage lender to determine which option is best for your custom financial situation.

It's also worth noting that when refinancing an FHA loan into another FHA loan, you will be required to pay a single upfront insurance premium followed by monthly mortgage insurance premiums (MIPs). These premiums will vary depending on the loan amount, the type of refinance, and other factors.

Why Refinance an FHA Loan?

There are several reasons why you might consider refinancing your FHA loan. One of the most common reasons is to lower your monthly payment. If interest rates have gone down since you first took out your FHA loan, refinancing to a lower interest rate could save you a money each month and a significant amount over the life of the mortgage.

Another reason to refinance an FHA loan is to get cash out of your home equity. If your home has increased in value since you first took out your FHA loan, you may be able to refinance and take out some of that equity in the form of cash. This can be a great way to pay off high-interest debt or make home improvements.

You might also consider refinancing your FHA loan if you have an adjustable-rate mortgage (ARM) and want to switch to a fixed-rate mortgage. With an ARM, your interest rate and monthly payment can change over time, which can make budgeting more difficult. Switching to a fixed-rate mortgage can give you more stability and predictability in your monthly payments.

Finally, you might consider refinancing your FHA loan into a conventional loan if you want to remove the mortgage insurance premium that is mandatory on FHA loans. When you put 10% or more down, you pay MIP for 11 years; if you put less money down, you pay it for the life of the mortgage. This premium can add 0.15% to 0.75% to your monthly payment, so removing it will definitely save money (unless the closing costs are too high to be worth it).

Types of FHA Loan Refinancing

There are two main types of FHA loan refinancing: a rate-and-term refinance, and a cash-out refinance.

FHA rate-and-term refinance.

A rate-and-term refinance is the most common type of FHA loan refinance. It involves refinancing your FHA loan to change the interest rate, the term, or both. The primary goal of this type of refinance is to reduce the mortgage payments, but it can also be done to pay off the home sooner, thus saving big on interest. For example, if you currently have 18 years left on an FHA loan with a 7% interest rate, then refinancing to 5% for 15 years should not only lower your payment but also save you a lot of money on interest.

When considering a rate-and-term refinance, it's important to compare the new mortgage estimates (APR, closing costs, total interest to be paid, and so on) to the existing mortgage to ensure that you would be getting a better deal by switching.

FHA cash-out refinance.

A cash-out refinance is another type of FHA refinance that allows you to tap into your home equity and take out cash. With this type of refinance, you pay off the current mortgage with a new loan for a higher amount, taking the difference in cash.

For example, if your home is worth $300,000 and you currently owe $200,000 on your FHA loan, you may be able to refinance for $250,000, pay off the old mortgage, and keep the leftover $50,000 in cash. The money from a cash-out refinance can be used for anything, such as paying off high-interest debt, making home improvements, or funding a large purchase.

It's important to note that a cash-out refinance will usually increase your monthly payment. The exception is when your new interest rate is so much lower than your old one you still come out ahead. A cash-out refi could also extend the loan term, thus setting you back. Additionally, you will need to have a certain amount of equity in your home to qualify for a cash-out refinance, and your equity determines how much cash you could get out.

How to Refinance an FHA Loan

Refinancing an FHA loan is similar to refinancing a conventional loan. Here are the general steps you would need to follow.

• Check your credit score and debt-to-income ratio (DTI): Your credit score and debt-to-income ratio will impact your ability to qualify for a refinance and the terms of the loan.
• Gather your financial documents for the refi: You will need to provide documentation of your income, employment, debts, and assets to the lender.
• Shop around for a lender: It's important to shop around and compare offers from different lenders to find the best deal.
• Apply for a refinance: Once you've chosen a lender, you will need to complete an application and provide the necessary documentation.
• Wait for the loan to be approved: The lender will review your application and documentation to determine whether you qualify for a refinance.
• Close the loan: If you're approved, you will need to sign the necessary paperwork and pay closing costs to complete the refinance.

When refinancing an FHA loan, you will need to meet the eligibility requirements, such as having a minimum credit score of 500, meeting debt-to-income ratio requirements, and having a steady employment history. Additionally, you will need to meet the FHA's loan limits, which vary by county.

Benefits of Refinancing an FHA Loan

Refinancing an FHA loan in the United States can offer several benefits for homeowners. Here are some of the main advantages.

Lower monthly payment.

One of the main reasons to refinance an FHA loan is to lower the monthly payment. This can be achieved by refinancing to a lower interest rate or extending the loan term, though nobody recommends going backward, so you should really try not to add years to your mortgage. A lower monthly payment can free up funds for other needs, such as retirement savings or college tuition.

Shorter loan term.

Refinancing to a shorter loan term will let you pay off your mortgage faster and save a lot of money on interest over the life of the loan. Alternately, you could still save money on interest but avoid a refinance by paying more toward the loan principle every month or when your finances allow, and this has the effect of shortening the loan term too.

Cash-out option.

A cash-out refinance allows you to convert some of your home equity into cash. This money can be used for any purpose, such as paying off high-interest debt, funding home improvements, or financing a large purchase. The interest rates on home equity loans or credit cards are usually higher than mortgage rates, so a cash-out refinance is often a better alternative to other loans.

Ditch an adjustable-rate mortgage for a fixed-rate mortgage.

If you have an adjustable-rate mortgage, your interest rate and monthly payment will probably change over time. Refinancing to a fixed-rate mortgage can provide stability and peace of mind by locking in a monthly payment that will never surprise you.

Drop the mortgage insurance.

FHA loans require mortgage insurance premiums (MIP) regardless of the down payment amount. If you have enough equity in your home, you may be able to refinance to a conventional loan and thus remove the MIP, which will save you money.

Improved credit score.

If you have been making on-time payments on your FHA loan, refinancing to a conventional loan with a lower interest rate can improve your credit score. This can make it easier to qualify for other types of credit, such as car loans and credit cards.

There Will Be Closing Costs

Keep in mind that refinancing an FHA loan comes with costs, such as closing costs and appraisal fees. Always weigh the potential savings against the costs of refinancing to determine if it's the right decision for your financial situation. A rule of thumb is that the amount you would save per month should cover the closing costs within 30 months, or else don’t choose that loan.

You have two options for paying closing costs. The first is to pay them up front in cash. The more expensive option is to roll the closing costs into the loan, which means you have to pay interest on them.

Conclusion

In conclusion, refinancing an FHA loan when rates are favorable offers several benefits to homeowners, such as lowering the monthly payment, shortening the loan term, converting home equity into cash, and removing mortgage insurance.

It's important to compare offers from different lenders, check eligibility requirements, compare interest rates, and consider the costs of refinancing before making any decisions. Refinancing can be a smart financial move for some homeowners, but it's not the best choice for everyone all the time.