Can An FHA-to-Conventional Refinance Save You Money?

How do you refinance an FHA loan to a conventional mortgage, and why would someone do it?

First, the why. (Spoiler alert: It’s all about the money.) And then we’ll dig into how you qualify for the refinance.

Why Refinance an FHA Loan to a Conventional Mortgage?

The great thing about all refinances is that they’re a simple matter of math. You’re asking yourself four questions:

1. Will the refinancing make me better off?
2. By how much?
3. If I’m making savings (as opposed to taking cash), when will my savings pay for my closing costs, i.e., when will I break even?
4. Do the savings I’m making or the cash I’m taking out make this refi worthwhile?

You’re working with ballpark figures to begin with. You just want to decide whether the refinance is worth exploring further. Our refinance calculator can do the hard math for you.

But, once you get quotes (formally called “loan estimates”) from multiple lenders and pick the best one, you’ll work with pretty solid figures. A lender needs very good reasons to revise a loan estimate once one’s issued and you’ve locked your rate. 

How Should an FHA-To-Conventional Refinance Improve Your Loan?

There are two main ways in which you might financially benefit from any refinance:

1. Rate-and-term — You reduce your monthly payment by getting a lower interest rate or by extending the period over which you pay down the borrowing on your home
2. Cash-out — You walk away from closing with a lump sum, which you can spend on anything you like. Many use these for home improvements or debt consolidation

Currently in 2024, few people refinance at all. Mortgage rates are near two-decade highs and most people cannot get a lower mortgage rate than the one they were already paying. 

Still, the Mortgage Bankers Association reported that all forms of refinance were 26% higher in the week ending Jun. 21, 2024 than the same week one year earlier. That month, it was expecting the percentage of all mortgage applications that are refinances to keep growing through 2024 and 2025.

That’s partly because many experts expect mortgage rates to fall in the future and partly because of continuing demand for cash-out refinances and those that extend mortgage terms. 

Eliminating Mortgage Insurance Can Make the Refinance Worth It

There’s an important difference between FHA and conventional loans that can make a refinance from the first to the second irresistible. That difference is mortgage insurance, also known as PMI or private mortgage insurance.

Anyone with a down payment lower than 20% is likely to have to pay mortgage insurance. It does nothing for you, but it insures the lender if you default.

However, you can stop paying mortgage insurance once the balance on your conventional mortgage is 80% or less than your home’s value. 

You have to pay mortgage insurance on an FHA loan forever—or at least 11 years if it’s a 15-year loan. In most cases, the only way to avoid this is to refinance or get a conventional mortgage.

Even if you refinance into a conventional mortgage with PMI, that fee will drop off once you pay the loan down to 78% of its original balance.

How Much Is Mortgage Insurance on an FHA Loan?

In 2024, most borrowers pay 0.55% of the loan amount each year. So, if you’d borrowed $300,000, you’d be paying $1,650 a year or $137 per month.

We’d all like to save $137 a month. But it will only make financial sense if the mortgage rate you’ll pay on your conventional loan isn’t so much higher than your current FHA one that your monthly payment rises by more than you can save.

As we said, refis are all about the math.

You don’t have to wait to refinance until your mortgage balance dips below 80% of your home’s value. You can refinance an FHA loan to a conventional mortgage with just 3% in equity. But you won’t avoid mortgage insurance until you reach 20-22% equity, depending on your mortgage servicer’s rules at the time. 

Refinance Requirements Going From FHA to Conventional

To stand a good chance of getting approved for an FHA loan to a conventional mortgage refinance, you’ll likely need:

• Minimum 3% equity, or 20% to immediately avoid mortgage insurance
• A credit score of 620 or better
• Documented income
• Enough in your checking or savings accounts to pay for closing costs unless you have adequate equity to roll those into the new conventional loan
• Debt payments, including the new mortgage, equaling no more than 45% of your monthly income. That’s a 45% debt-to-income (DTI) ratio

Your lender will likely require a similar mountain of supporting paperwork to the one you had to provide for your FHA loan application, plus proof of homeowner’s insurance. 

It will also need an appraisal of the home, which it will normally commission at your expense. Appraisal fees are part of normal closing costs.

Be sure to get quotes from multiple lenders for any sort of refinance. Just as with all mortgage applications, you can save many thousands of dollars by hunting down your best possible deal. 

Once you’ve chosen your lender, the refinance process is very similar to that for mortgage applications.

Is It Worth It to Refinance From an FHA to a Conventional Loan?

It rarely makes sense to refinance to a higher mortgage rate than the one you’re currently paying. But, if the difference is very small, escaping mortgage insurance might tilt the calculation. 

And, if you have an urgent need for cash, paying a higher rate can be worth it. It’s not financially wise, but sometimes desperate measures are called for. 

At the time this article was written, mortgage rates were close to 21st-century highs. However, many expert economists expected them to fall soon. 

And each small decrease in mortgage rates increases the number of homeowners for whom all refinances — and especially an FHA loan to a conventional mortgage refinance — make sound financial sense.

So, why not explore your options now?