How to Refinance from a USDA Loan to a Conventional Loan

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Do you currently have a USDA loan? The U.S. Department of Agriculture offers a variety of loan products for low-income individuals and families living in rural areas and running farms.

For the fiscal year that ended September 30, 2023, the USDA issued over $4.7 billion in funding for farm-related loans.

However, a USDA loan might not be the long-term financing option you are looking for, especially if you plan on converting your home into a rental property. In this article, we’ll cover a few reasons why converting to a conventional loan might be beneficial and what the refinancing process entails.

Why Refinance from a USDA Loan to a Conventional Loan? 

USDA loans have countless limitations, including cash-out refinancing and occupancy requirements. Let’s cover a few of the reasons you might choose to refinance your USDA loan. 

Remove Home Equity

If you want to cash out equity in your home, you will need to convert your loan to a conventional, VA, or FHA loan. USDA loans cannot have a Home Equity Line of Credit (HELOC) on the property.

Additionally, USDA loans prohibit cash-out refinancing. 

Owner-Occupancy Changes

In addition, USDA loans are designed for owner-occupied properties, with financing terms based on your specific financial situation. If you plan on converting your home into a rental property, you might not qualify to hold a USDA loan.

Similarly, USDA loans cannot be used for vacation or second homes. Purchasing a new primary residence can disqualify you from holding a USDA loan. 

Removal of Private Mortgage Insurance

Another reason why you might choose to refinance a USDA loan into a conventional loan is because of mortgage insurance. The USDA does not impose Private Mortgage Insurance (PMI), but they do have a similar fee added onto your loan.

This fee is charged through an upfront guarantee fee and an annual fee on top of mortgage payments. Refinancing to a conventional loan with more than 20% equity removes these charges. 

Shorten Your Loan Term

USDA loans only offer a 30-year repayment period. To reduce the length of your loan to 10, 15, or even 20 years, you will need to refinance to a conventional loan. 

USDA Refinancing

The USDA does offer loan refinancing. However, the same restrictions apply to newly refinanced loans, which is why many borrowers pursue a conventional loan. There are three main USDA refinancing options. 

  • USDA Streamlined-Assist Refinance—This process is best if you want to lower your interest rate and loan payment. It is available if you have minimal equity in your home. 
  • USDA Streamlined Refinance—This program is similar to the USDA Streamlined-Assist Refinance program. It won’t require a new appraisal, but the lender will do a credit and income check.
  • USDA Non-Streamlined Refinance—This loan program is similar to taking out a new mortgage with a new appraisal, full income review, and credit check. 

These refinance options should only be used if you want to lower your monthly payment and remain within the USDA loan program. 

The Refinancing Process

If you decide that refinancing is the right option for your USDA loan, you must go through a process similar to taking out a new loan. Remember, this process will look different for each borrower, so consult with a qualified lender to learn more.

Nevertheless, here are the steps you can expect: 

Step 1: Understand Your Loan

Before starting the refinance process, you must ensure your loan is eligible. The USDA has a mandatory 12-month holding period.

This means you aren’t able to refinance your USDA loan for 12 months after it’s taken out. In addition, you must have at least 3% equity in your home and have been making payments on time for 180 consecutive days. 

Step 2: Find a Lender

Not all lenders have the credentials and capabilities to refinance a USDA loan into a conventional loan. When looking for a lender, confirm they understand the intricacies of your USDA loan.

Each loan will have different requirements, such as holding period and occupancy. You want to work with a lender who can comply with USDA regulations. 

Step 3: Negotiate Terms

Part of the refinancing process will involve a home appraisal and determining your borrowing eligibility. Even though your home may appraise at $400,000, you might only be able to borrow $350,000.

This is where negotiation comes into play. Lenders do have some leeway to work with you based on your situation.

Consider negotiating your repayment term, interest rate, appraisal amount, closing costs, and monthly payment. 

Step 4: Close

Once you’ve negotiated your terms and agreed with your lender, you will close on your new loan. Remember, a refinance process eliminates the old loan, meaning you will have no further ties to your USDA loan.

This gives you flexibility in opening a HELOC, removing PMI, and converting your home into an investment property. 

The Bottom Line

Refinancing from a USDA loan to a conventional loan might make sense if you want to pull equity out of your home, remove mortgage insurance, or convert your primary residence into a rental property. 

The refinancing process looks different for each borrower. Don’t be afraid to shop around to find the right lender and negotiate on your terms. 

Sean Bryant

Sean Bryant is a Denver-based freelance writer specializing in personal finance, credit cards, and real estate. With more than 15 years of writing experience, his work has appeared in many of the industry’s top publications including Time and Investopedia . He holds a Bachelor of Arts degree in economics.

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