When to refinance an FHA loan to a conventional loan

With its lenient down payment and credit score requirements, an FHA loan can be an ideal starter mortgage. But the steep fees that accompany FHA loans add up.

So if you used an FHA mortgage to buy your home, you might now be comparing refinance rates to move from an FHA loan to a conventional loan. Here’s what to think about before making the switch.

Can you refinance an FHA loan into a conventional loan?

Before comparing conventional loan refinance rates, you might be wondering: Is it even possible to refinance from an FHA loan to a conventional loan?

Yes, it is, so long as you meet the standards for approval of a conventional loan. Some of most common minimum requirements include:

  • A credit score of at least 620
  • Equity ratio of at least 20 percent in your property (that is, you own 20 percent of it outright)
  • Debt-to-income (DTI) no higher than 45 percent
  • Proof of income and insurance

When is it a good time to refinance an FHA loan to a conventional loan?

Just because you can be approved for a new loan doesn’t mean you should refinance. Here are a few cases when it might make sense to move from an FHA to a conventional mortgage:

  • Your credit score has improved. Let’s say your credit score was 600 when you took out the FHA loan. Four years later, it’s now 670. That’s a huge difference that can help you qualify for a more affordable loan. (If your score has climbed above 700, even better.)
  • You could get a lower interest rate. This is a tricky one – mortgage rates have topped 7 percent as of August 2023, so low rates are hard to find. However, it’s worth checking. Look at the market now versus when you applied, and use Bankrate’s refinance calculator to estimate your savings with a lower rate.
  • You’re planning to stay put. If there are no plans of moving in your future and you still have a long time left on your current loan, a conventional loan refinance can be a smart decision. However, if you’re planning to move in the next couple of years, refinancing might not be wise, because you might not have enough time to hit the break-even point where your savings outweigh the upfront closing costs on a new loan.
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Pros and cons of refinancing from FHA to conventional loan

Pros

Switching from an FHA to a conventional loan comes with a host of benefits. Here’s a closer look:

  • You can get rid of FHA mortgage insurance. In most cases, for FHA loan originated after 2013, you have to pay mortgage insurance premiums (MIP) on FHA loans for the loan’s lifetime. (The only exception is if you made a down payment of 10 percent or more; then the PMI is canceled after 11 years.) Refinancing into a conventional mortgage is the only way to cancel it.
  • You can lower mortgage insurance costs. If you refinance your FHA loan to a conventional loan and still incur mortgage insurance (due to your home equity level), you might find that the premium costs more now than what it cost for your FHA loan. Refinancing, however, could lower your monthly payments enough to compensate, and the tradeoff is that you’ll be able to cancel private mortgage insurance, eventually, on the conventional loan (once your outstanding loan balance drops to 80 percent of your home’s value).
  • You can convert your home equity into cash. Conventional mortgages allow you to tap up to 80 percent of your home’s equity through a cash-out refinance without paying mortgage insurance.
  • You can possibly access larger loan amounts. Conventional loans also have higher loan limits, so you can take out a larger amount compared to an FHA loan. The 2023 FHA mortgage limit for single-unit properties is $472,030, a fraction of the $726,200 limit for conventional loans. (This figure increases to $1,089,300 for homes in high-cost areas).
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Cons

While conventional refinance rates tend to be lower than FHA refinance rates, it’s not all roses if you switch to this new type of loan. Consider these drawbacks:

  • You might still pay mortgage insurance for a while. Those PMI payments will still add up, so be sure to ask a lender for an estimate of how much your premiums would be if you still haven’t hit the 80 percent mark.
  • Refinancing isn’t free. Since refinancing is essentially getting a new mortgage, you’ll once again incur closing costs, which — though cheaper than for purchase loans — are still substantial on large mortgages. As of the end of 2021 (the most recent data available), the average refinancing closing costs were $2,398 — an increase of almost 5 percent from the year before — though in some states they can mount as high as $4,600. Depending on your lender, you might be able to roll these costs into your loan, but that will ultimately increase your new monthly payment.
  • You’ll have to go through the entire loan process again. Remember all the work you had to do to get approved for your first loan? Get ready to do it again. Conventional refinancing involves a lot of paperwork and a lot of back-and-forth exchanges with your lender. In August 2023, according to Ice Mortgage Technology, the average time to close a conventional refinance loan was 47 days.

Alternatives to FHA loan refinancing

If refinancing your FHA loan to a conventional loan isn’t right for you, you can still take advantage of lower interest rates by doing an FHA streamline refinance. This program offers a faster way to refinance your FHA loan because it does away with more stringent underwriting, such as the need to verify your income and credit or do an appraisal.

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To qualify for an FHA streamline refinance, you’ll need to meet the following requirements:

  • You currently have an FHA loan.
  • You’ve been making your payments and your loan is in good standing (not delinquent).
  • Refinancing results in a “net tangible benefit,” such as lowering your monthly payment or changing from an adjustable-rate loan to one with a fixed rate.
  • You’re not looking to take out more than $500 in equity.

Final word on refinancing FHA loans

The decision to refinance from a FHA loan to a conventional loan can make sense for many homeowners, especially if you are currently paying mortgage insurance premiums and you see an opportunity to lower your interest rate. That being said, you should always use a mortgage calculator to see if you’ll actually save money.

Carefully consider the pros and cons, estimate your costs and explore all of your options, including an FHA streamline refinance, so you make the best possible decision for your circumstances.

Additional reporting by Allison Martin