Once you've applied for an FHA loan and received approval, refinancing may be the furthest thing from your mind. But depending on your situation, it's something to begin thinking about as it could save you money. It's even worth knowing before you receive an FHA loan that refinancing is an option and to learn how it can help you in the future.
The financial downside of an FHA loan is paying a mortgage insurance premium on top of the loan amount. This MIP is added to the loan balance as a separate upfront amount (UFMIP) of 1.75%.
Another downside is the PMI (private mortgage insurance). The PMI lasts for the life of the loan, which is an excellent reason to consider refinancing as soon as you're able.
Two main types of FHA loans are fixed-rate and adjustable-rate. Fixed-rate loans can last either 15 or 30 years and have a set, or fixed, the interest rate that won't change. They require a minimum credit score that's usually around 580, depending on the lender.
Read more: Credit score needed to buy a house
With an adjustable-rate loan, the rate adjusts throughout the loan. With a one or three-year loan, the interest rate could increase to one percentage point after either one year or three years.
With a five year adjustable rate, the rate can increase up to one point per year after five years. There is also a seven or ten-year adjustable rate, in which the rate can increase up to two percentage points per year after that fixed period.
Adjustable-rate loans start with a very low rate of interest, so it's a good option if you plan to sell the home before the rate increases or are able to refinance in the future.
Basically, when you are refinancing, you are paying off the existing loan and starting with a new one. Since it's a new loan, there will be closing costs, but those can be rolled into the payments for the new loan.
Because refinancing requires changing the terms of the loan based on current market conditions, you need to ensure it makes financial sense.
So you may have originally gotten a loan when rates were 6%, but if they drop to 4%, it's a good time to refinance for a lower interest rate.
Conversely, if interest rates rise, then refinancing may not be a wise financial decision.
Sometimes refinancing involves getting a completely new loan starting from scratch; in other circumstances, the paperwork used for the original loan can be used to facilitate the refinanced loan.
By refinancing, you can save money and pay off the mortgage more quickly, or you can borrow cash against your house to pay other debts or for home projects.
Sometimes a refinance doesn't make sense if it will add significant years to the life of the loan or if the amount of interest paid increases.
Refinancing an FHA loan into another FHA loan isn't an option unless you've had the mortgage a minimum of 210 days (around seven months) from closing and have not had any late payments during that time.
Once the loan is refinanced, you can refinance again when another 210 days have passed with no late payments.
but you may have to wait a minimum of 6 months before you can apply to refinance.
A lender will allow refinancing only if:
Moving to a fixed-rate loan is almost always a good idea if you'll be paying a lower interest rate than the adjustable-rate increase.
When interest rates drop, it's a good time to consider refinancing. An opportunity to lower your mortgage payments can help you pay your loan faster or help safeguard your ability to make future payments.
If you have an adjustable-rate mortgage and your rate will be increasing soon, switching to a fixed-rate mortgage could be a good idea. It ensures your payments will be consistent, and your payment won't suddenly jump.
When you refinance, you may also wish to shorten the length of your loan. For instance, if you originally had a 30-year loan, but with a lower interest rate, your payments will be significantly reduced, you may be able to change to a 15-year loan if the monthly mortgage payments don't increase by more than $50. This means you should be able to pay off your mortgage more quickly.
There are two types of refinance programs..
A streamline refinance is only for lowering the rate and term. It is a quick process since income documentation, and an appraisal is not needed.
This makes it extremely easy for the homeowner to refinance more quickly; no old documents need to be found, no home appraisal is needed, so the homeowner saves money.
A cash-out refinance provides you with cash in place of a portion of what you've already paid for your house. So if your home is valued at $200,000 and you owe $100,000, you can take a loan for $150,000 and receive $50,000 in cash.
This excess cash can be used for home improvements or to pay other debts. Cash-out refinancing takes a bit longer than a streamline since an appraisal is required and income verification.
Cash-out typically takes about 30 days from start to finish, as long as paperwork is being provided in a timely manner.
Another cash-out option is to refinance from an FHA loan to a conventional loan or a VA loan. Why is this called cash-out? Not sure, but that is what the mortgage industry calls it.
Refinancing into a conventional only makes sense if you are saving money on the mortgage insurance or the principal and interest payment.
Otherwise, you will owe PMI (private mortgage insurance) on the conventional loan, which will most likely negate any savings from removing PMI on the FHA loan.
The benefit of PMI on a conventional loan is that it can be canceled when the homeowner has enough equity without needing to refinance, and there's a possibility it will be cheaper depending on your home's value.
PMI on an FHA loan is on there for life and cannot be removed unless you refinance out of the program.
If the interest rates are higher than when you obtained the loan, if your adjustable-rate mortgage is still low or if you don't have enough money or equity to cover closing costs, then refinancing might not be the right choice.
New closing costs will likely be between 1% to 2% of the total loan.
Even though costs can be rolled into your loan that's an additional expense that may not be worth a slightly lower interest rate.
FHA loans are government loans backed by the Federal Housing Administration. They're popular for first time home buyers because the down payment can be as low as 3.5% of the home's value even if the home buyer has a credit score as low as 580. It also allows home buyers to have a higher debt to income ratio, making it easier for anyone paying off a large amount of debt to still be able to purchase a home. The FHA was formed more than 80 years ago during the Great Depression as a way to make it easier for first-time homebuyers to obtain loans. Today the FHA insures more mortgage loans than any other entity in the United States.
Want to know more? Go here >> FHA Loans - Simple Guide
It's always possible to refinance an FHA loan but always do the math first. Talk to a loan officer to determine if it's the best decision for you and your home. Refinancing to save money or to add to the value of your home is worthwhile as long as you can continue to make payments on time without being stretched too thin.