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If you’ve noticed a recent spike in interest rates for home loans, you may be considering refinancing your Federal Housing Administration (FHA) loan before rates rise further. Here’s how you can refinance an FHA loan and what options to consider.
How to Refinance an FHA Loan
You can refinance an FHA loan to lower your interest rate or monthly payment, freeing up more money to pay off other debts or save for emergencies. But the loan that’s right for you depends on your needs, current interest rates, and how long you’re paying off your existing loan.
There are several ways to refinance an FHA loan:
- Take out a new FHA loan to replace your current FHA loan
- Take out a conventional loan from a private lender to replace your current FHA loan
FHA Refinance Options
Each refinance option and lender has different requirements, but most require a credit check, income verification, and proof of solid payment history on your current home loan.
Here are your options when it comes to refinancing your FHA loan:
- FHA streamline refinancing. With minimal documentation and underwriting, the goal of an FHA streamlined refinance is to refinance your home faster compared to other types of home loans. You can qualify for a simplified FHA refinance if you are current on your current mortgage and it is already FHA insured. But the maximum you will receive in cash is $500.
- Refinancing by collection of the FHA. This is when you refinance your home for more than it’s worth and collect the difference. The amount you get depends on the equity in your home. The more equity there is, the more you are eligible to receive. Certain FHA requirements apply, such as having at least a credit score of 580.
- Simple FHA Refinance. This involves swapping your existing FHA loan for a new one, such as going from a fixed rate to an adjustable rate mortgage (ARM) or vice versa. However, there is no option to withdraw cash, so you cannot refinance more than your home is worth.
- Rehabilitation loan. Commonly referred to as a 203(k) rehabilitation loan, this type of refinance allows you to have mortgage payments and renovation costs in one loan. While some people take out a home equity loan or line of credit to manage home improvement or remodeling costs, you can do that with just one FHA loan.
- Refinancing into a classic loan. You can also take out a conventional loan from a private lender when refinancing. You could get lower interest rates and, in some cases, you could shorten your repayment terms so you can pay off your loan faster. But that means potentially higher monthly payments, so only do it if you can afford it.
When considering these options, keep in mind that refinancing your FHA loan to a conventional mortgage requires more documentation and a higher credit score compared to FHA loan requirements.
Discover: What credit score is needed to refinance my mortgage?
Benefits and Risks of FHA Refinancing
Before choosing to refinance into an FHA loan, it’s a good idea to weigh the pros and cons to make sure the time and money spent is with the long term benefits.
Benefits of an FHA Refinance
- Lower monthly payment. If you took out your original FHA loan with a decent or poor credit score, you may not have gotten the lowest interest rate available. By building up a history of on-time payments, your credit score has likely gone up. Refinancing with a higher credit score potentially means lowering your interest rate, which can lower your monthly payments.
- Remove mortgage insurance. If you have at least 20% of your home’s equity, refinancing into a conventional loan could remove mortgage insurance – extra charges on your home if you couldn’t put 20% aside when you took out the mortgage for the first time. This insurance benefits the lender in case you miss a payment. However, all FHA loans have mortgage insurance, so if you refinance with another FHA loan, you will likely have to pay for mortgage insurance.
- Cash in on the equity in your home. Rather than taking out a second mortgage to cover home improvement costs or pay off debt, you can cash out the equity in your home through a cash refinance.
Risks of an FHA Refinance
- Closing costs. As with a regular mortgage, you are responsible for closing costs when you refinance your home. These may include valuation fees, underwriting fees, title services and other costs. You could owe 2-5% of your total outstanding loan, which is similar to the closing costs of a traditional mortgage.
- More stringent requirements. If you are refinancing an FHA loan to a conventional loan, you may need to meet higher standards. For example, your debt-to-income ratio (DTI) should be 50% or less, but the lower your DTI, the more likely you are to get the best deal. You will also need at least a credit score of 680 (varies by lender). If you’re switching to another FHA loan, the requirements might not be as stringent, but you’ll still need to prove your creditworthiness.
- Potentially higher payouts. Refinancing does not guarantee lower payments. In fact, if you don’t get a lower interest rate, you could be facing much higher payments than what you’re currently paying. Along with this, refinancing with a shorter term loan means higher monthly payments in order to pay off the mortgage faster. So if you can’t afford the jump, refinancing might not work for you.
Should You Refinance Your FHA Loan?
Many refinance options require you to own the home for some time, often more than a year or more. The more one-time payments you can show on the house, the more likely you are to qualify.
The best FHA mortgage lenders offer the lowest fees and the most repayment terms. If you don’t have many options to choose from, if you can’t get an interest rate lower than what you’re currently paying, or if you have no way to pay off your loan sooner, you may not want to be not refinance your FHA. ready.
Instead, take the time to improve your credit score and build your home equity. That way, you’ll be set to get a lower rate and potentially tap into more of that equity.
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