You don’t have to be an FHA buyer to consider an FHA loan refinance. The FHA program has many benefits including being able to borrow up to 96.5% of the home’s value in a rate/term refinance and up to 85% in a cash-out refinance.
Does there have to be certain circumstances in order for you to use the FHA refinance?
Luckily, there doesn’t. Anyone can refinance into an FHA loan. We look at who this loan suits the best and in which situations.
What’s Your Credit Score?
Your credit score is one of the largest indicators of the right program for you. If you have a great credit score, you may want to consider conventional financing. A score over 700 is considered great, but typically, lenders allow a score over 680 for this loan program. Conventional loans often have good rates and they don’t charge upfront mortgage insurance like FHA loans do. But, they have stricter debt ratio requirements and will require PMI if you borrow more than 80%. In fact, you can only borrow up to 95% in a rate/term refinance. If you want to take cash out, you can only borrow up to 80%.
If you have a credit score below 680, you’ll likely be a better candidate for the FHA loan refinance. FHA loans have more flexible guidelines including lower credit score requirements. In fact, they allow credit scores as low as 580, but you might be hard-pressed to find a willing lender if your score really is that low. FHA loans do charge an upfront mortgage insurance fee as well as monthly mortgage insurance for the life of the loan.
What’s Your Debt Ratio?
Another indicator of which loan will suit you best is the debt ratio. Conventional loans allow front-end debt ratios of 28% and back-end ratios of 36%. This means your housing payment cannot exceed 28% of your gross monthly income and your total debts, which include your credit card payments, car loan and personal loan payments along with the mortgage cannot exceed 36% of your gross monthly income.
If you exceed these numbers, the FHA loan may be a better option. The FHA loan allows a front-end ratio of 31% and a back-end ratio of 43%. These ratios are much more forgiving than conventional loans, allowing you to have more debt and still refinance your loan.
What’s Your LTV?
Another important factor in the loan you choose is your LTV. As a reminder, FHA loans charge mortgage insurance for the life of the loan. It doesn’t matter what your loan’s LTV is; unless you refinance, you pay the MIP.
If you owe less than 80% of your home’s value, though, you may be better off with a conventional loan. These loans charge PMI, but only for loans with an LTV higher than 80%. If you take a conventional loan and then you pay the balance down below an 80% LTV, you can request that the lender cancel the PMI. If you are close to an 80% LTV when you refinance, it might make sense to choose the conventional loan so that you only pay PMI for a short time.
Do You Have a Current FHA Loan?
The final determining factor is the loan you have right now and the purpose of your refinance. If you have an FHA loan and you simply want to refinance into a lower rate, you may benefit from the FHA Streamline Refinance Loan. This loan program requires you to verify only your mortgage payment history. The FHA requires that your FHA loan payments are made on time for the last twelve months in order to qualify.
Other than the mortgage payment history, the lender can use all of your original qualifying factors for the loan. In other words, you don’t have to verify your income, assets, liabilities, or your home’s value. The FHA feels that if you have a timely mortgage payment history that you’ll be able to afford the loan with the lower rate.
The only requirement is that you have to have a net tangible benefit for the refinance. In other words, there has to be a good reason for the refinance. This is the FHA’s way of eliminating excessive refinances. Refinancing costs money and it resets your mortgage term, which could prevent you from ever getting ahead if you do it too much. If you can save money, though, it can make sense to do so.
Before you refinance, it makes sense to weigh all of your options. Look at both conventional and FHA options to see which one will save you the most money now and in the long run. You want the loan that suits you now as well as long into the future as a mortgage can last for another 30 years, which could mean a lot of interest over the life of the loan.