How to Refinance an FHA Home Loan
As the housing market continues to rise, many homeowners have gained a large amount of equity in their home in just the last couple of years. Even though loan interest rates have started to increase, many homeowners can still benefit from refinancing their FHA loan and use the extra money to pay off other forms of debt such as remaining student loans or credit card debt.
Refinancing an FHA home loan is possible, but in order to do it efficiently, you’ll need to plan ahead. If you’re interested in the process of refinancing an FHA loan or you’ve already crunched the numbers and know that refinancing is in your best interest, then here’s a quick guide to help get you started!
When Should You Refinance an FHA Home Loan?
There’s no specific time or date when refinancing your loan is best, but there are a few signs that it may or may not be a good idea. The biggest factor is, of course, the breakeven point. If you’re unable to reach it, then refinancing can end up costing you more than if you had stayed with your original loan.
The breakeven point will vary for every homeowner, but using a refinance calculator will provide you with the most accurate information about your estimated breakeven point. As long as you’re confident you’ll meet it, a refinance could be well worth it.
Another indicator that a refinance is a good idea is if you’re able to reduce your interest rate or remove MIP payments. This can save you money, but only if you meet all the eligibility requirements and are sure you’ll meet your breakeven point.
How Do You Refinance an FHA Loan?
#1. Check Your Eligibility
The thing about FHA loans is that yes, they can be refinanced, but not everyone is eligible. This can be a hassle if you didn’t realize it before beginning the refinance process, so that’s why it’s listed here as step one.
Depending on the type of refinance you’re interested in (streamlined or cash-out), the eligibility requirements will look slightly different.
If you choose a streamlined FHA refinance, all you need to do is a current FHA mortgage that is at least six months old. It must be in good standing, meaning you’ve consistently met payments and not had any other problems during the loan term. It’s much easy to qualify for a streamlined refinance, but you won’t be able to take money out.
If you choose a cash-out or regular FHA refinance, you’ll need to meet the following eligibility requirements:
- Prove that your home is your main place of residence
- Must have lived in the home for at least 12 months
- Have a track record of on-time payments for the last 12 months or longer
- Have a loan to value ratio that is below 80%
- Have a debt to income ratio below 50%
- Have a credit score of at least 500
#2. Find a Lender
If you meet the eligibility requirements for the FHA refinance of your choosing, then it’s time to look for lenders. Every lender will have different rates and may have additional eligibility requirements, so take your time looking around at all the different lenders in your area and choose wisely.
It’s important to know how to find a good lender. Not every lender will have policies you like or provide the customer service that you want, so be sure to ask questions, compare rates, and don’t be afraid to change your mind.
#3. Decide on a Loan and Apply
When you decide to refinance your FHA loan, you may think that you’re limited to other FHA loans. This isn’t the case, though, and many people decide to refinance to a conventional loan or a rehabilitation loan.
To refinance to a conventional loan, you’ll need to have at least 20% equity in your home and a good credit score. However, there can be benefits to switching to a conventional loan if you’re planning on refinancing.
With a rehabilitation loan, you can combine your mortgage and renovation costs into one loan. It’s very similar to a regular FHA loan but has a few extra steps. You’ll need to have your home appraised twice: once to determine your home’s value and another time to determine the estimated value of the home improvements.
Not every FHA lender will offer a rehabilitation loan, also referred to as a 203(k) Rehabilitation Mortgage. If you’re interested in this type of loan, though, you can use the Department of Housing and Urban Development’s search tool and select the 203(k) option at the bottom.
Whether you decide to stick with an FHA refinance or look into other types of refinances, you’ll eventually need to decide on the loan you want and apply. Just like when you applied for your first home loan, you’ll need to provide paperwork and pay an application fee. You’ll also want to consider getting pre-approved.
Risks of Refinancing an FHA Home Loan
As with every refinance, there are some risks involved with refinancing your FHA home loan. Before you take the first step, it’s important to understand what these risks are so you aren’t surprised.
#1. Closing Costs
Closing costs can be expensive and you’ll need to pay them for both the original loan and the new refinance. Due to this, it’s important to use a mortgage calculator in order to determine if a refinance is affordable and worth it.
#2. Possibility of Higher Payments
A lot of people try to refinance in order to lower their monthly payment, only for the exact opposite to happen. A lower interest rate may be appealing, but if you get trapped into making new MIP payments and the loan term is longer overall, it can lead to more expensive payments in the end.
Is a Refinance Worth it?
For some people, a refinance is definitely worth it but for others, it may not be in the cards. Depending on your personal financial situation, future plans or goals, and current eligibility, you may decide that a refinance is a good choice or you may decide to wait until you earn more equity in your home.
In either case, be sure to crunch the numbers and speak with potential lenders to determine just how affordable your refinance is and if it is worth the work.