Should You Refinance an FHA Loan to a VA Loan?

Are you thinking about refinancing your current FHA loan to a VA loan? It can be a money-saving move for most borrowers, but that’s not always the case. We’ll cover everything you need to know – the good and the bad – about doing an FHA to VA loan refinance.

What Is an FHA to VA Loan Refinance?

An FHA to VA loan refinance is when a homeowner replaces their existing FHA mortgage with a loan secured by the US Department of Veterans Affairs.

Not everyone will qualify for a VA refinance loan. In most cases, you must be either a current service member or an honorably discharged veteran. However, refinancing into a VA loan could be a wise decision if you’re able to do so.

Why Refinance Your FHA Loan Into a VA Loan?

The federal government backs both FHA and VA loans. However, there are numerous differences between these two programs. In many cases, VA loans can offer advantages over their FHA alternatives:

• Lower interest rates
• No monthly mortgage insurance premiums
• You can turn home equity into cash

Stop Paying the FHA Mortgage Insurance Premium

All FHA loans come with a monthly mortgage insurance premium (MIP). Since March 2023, the annual cost of mortgage insurance has been 0.55% of the loan amount per year, with the total divided evenly among your monthly payments. 

That’s nearly $140 per month on a $300,000 FHA loan. Could you think of better things to do with $140 per month?

If you took out your FHA mortgage before the March 2023 reduction, there’s a good chance that you have a higher annual mortgage insurance premium of 0.85% – over $210 per month.

This premium is an ongoing expense, regardless of the amount of equity in your home. In most cases, it lasts for the life of your mortgage. VA loans have no monthly mortgage insurance requirement.

VA Rates Are Typically Lower than FHA

Most borrowers will receive a lower interest rate on a VA loan than on a comparable FHA mortgage. 

According to the Optimal Blue Mortgage Market Indices, VA loan rates have trended about 0.20% to 0.30% lower than FHA rates.

VA loan rates are typically lower because the VA lowers the risk to lenders. They will pay back the lender a substantial 25% of the mortgage in the event of default. However, myriad factors impact quoted lender rates.  the rates. Some homeowners may still find better value with an FHA refinance.

You Can Cash Out Built-Up Equity With a VA Refinance

You’re under no obligation to, but if you have built-up equity in your home, there’s a good chance that you can convert it to cash as part of your FHA to VA loan refinance. Most VA lenders will allow you to borrow up to 90% of your home’s value, although some lenders may go up to 100%.

This means if you owe $220,000 on a $300,000 home, you may be eligible to take $50,000 in cash at closing, less closing costs ($300k X 90% = $270k – $220k loan balance = $50k).

Buying a Home With the Intention to Refinance VA Later

For some property owners, taking out an FHA loan to buy their home and refinancing through the VA later may have been the plan all along.

VA mortgages have fewer fixed guidelines than many other types of programs. This means that each lender sets its own minimum borrower criteria for VA loans, which are often more restrictive than those for an FHA loan.

For borrowers with a lower credit score or higher level of existing debt, it might make sense to purchase a home with a 3.5% down FHA loan and then refinance with the VA once their financial situation has improved. However, someone eligible for both loans will generally be better off going VA for their initial purchase.

4 Drawbacks of Refinancing From an FHA to a VA Mortgage

Despite having several advantages over VA loans, some drawbacks exist when refinancing with a VA mortgage. Some of the most impactful may include the:

1. VA Funding Fee
2. Closing Costs
3. Cash-Out Refinance Requirement
4. New Appraisal Requirement

1. VA Funding Fee for Refinances

VA loans do not require mortgage insurance like FHA loans. However, there is an upfront VA funding fee, typically 2.15% of the new loan amount. 

Repeat VA borrowers face a funding fee of 3.3%. Homeowners with a service-connected disability may be able to waive this cost.

While the funding fee can add a considerable expense to the process, remember that refinancing with another FHA loan would incur an upfront mortgage insurance premium (UFMIP) of 1.75% – nearly as much as the VA upfront fee.

2. Closing Costs on a VA Refinance

In addition to the funding fee, there are other costs associated with refinancing your loan. It’s not uncommon for total closing costs on an FHA to VA loan refinance to run 3% to 5% of the amount borrowed, or even higher in some cases.

It may be possible to roll closing costs into your loan, but this would mean paying long-term interest on the added balance. With some negotiation, some VA loan lenders may offer lender credits to cover expenses in exchange for a marginally higher interest rate.

3. Cash-Out Refinance Is Your Only VA Option

The VA only offers two refinance programs: the interest rate reduction refinance loan (IRRRL), which is limited to existing VA loan holders, and the cash-out refinance.

You would need to use the cash-out refinance option to replace your existing FHA loan with a VA loan. While VA loans are known for lower rates, cash-out refinances are riskier and typically incur higher interest costs than a simple rate-and-term refinance.

4. You Need an Appraisal; Home Needs to Meet VA Standards

Refinancing into a VA mortgage will require you to obtain an appraisal. Sometimes, a home that initially qualified for FHA financing could be ineligible under VA guidelines. The standards are similar, but there are still differences in what appraisers look for.

Plus, issues could have arisen since you purchased the home which prevent you from qualifying now.

Homeowners with an existing FHA mortgage who have trouble passing VA property standards should consider the FHA Streamline refinance program, which does not require an appraisal.

Refinancing and the Impact on VA Entitlement

If you qualify for a Certificate of Eligibility (COE) from the Department of Veterans Affairs and have never taken out a VA loan, you likely have “full entitlement.” This means the VA is willing to insure your mortgage, regardless of the size.

With most lenders, having full entitlement allows you to purchase a home with zero money down or convert an FHA loan to a VA loan.

The problem is that once you’ve taken out a loan using your full entitlement, you can’t get it back until you sell the home and pay off the loan, or have your mortgage assumed by an eligible service member or veteran. 

Simply paying off the loan or refinancing to a conventional loan doesn’t restore your entitlement.

However, the VA offers a one-time restoration of entitlement for buyers who have refinanced or paid off their VA loan yet still own the home. This would allow you to purchase or refinance another home with full entitlement, although the only way to restore your entitlement in the future would be to sell all of the associated properties.

If your VA entitlement is tied up on another home – but the VA loan is paid off – you can request the one-time restoration with VA Form 28-1880 to complete the FHA-to-VA refinance.

Is It Worth Refinancing My FHA Loan to a VA Loan?

Is it worth refinancing an FHA loan to a VA loan? Probably, but the answer can largely depend on your plans for the future.

How Long Will You Keep the Home?

Do you see yourself keeping the home long-term, or is there a chance you’ll sell within a few years? Even if you’re expecting significant monthly savings, it may take a while until you reach the break-even point where your savings exceed the closing costs of the new loan.

If you plan to sell your home or refinance again before then, retaining your current mortgage would likely make more sense.

Will You Convert the Home To a Rental?

If you plan to keep the home, do you see yourself purchasing something different and turning your current home into a rental? An FHA to VA loan refinance requires you to certify that you plan to continue using the property as your primary residence for at least 12 months.

Do You Need Your VA Entitlement For a Future Home Purchase?

While you could still rent it out down the line, doing so would tie up your entitlement and potentially prevent you from using it for your future homebuying needs. In this scenario, sticking with the FHA and saving your VA entitlement for your next purchase may make more sense.

Do You Plan to Own and Live In the Home for the Foreseeable Future?

If you anticipate living in the home for the foreseeable future and have no plans to purchase another property until you sell the current one, refinancing an FHA loan to a VA loan could save you big over the life of the mortgage.

Note: As a consumer protection measure, VA guidelines put a 36-month limit on the break-even point for refinance loans. Loans that would take longer to recoup your expenses cannot be approved.

Can An FHA to VA Loan Refinance Save You Money?

While VA loan rates are typically lower than with the FHA, not everyone will save money by refinancing. Homeowners who plan to sell in the next few years may be unable to recoup their closing costs. Also, those with ambitions to turn their home into a rental in the future may not want to tie up their VA entitlement despite a modest cost reduction. To find out what kind of savings you could expect from an FHA to VA loan refinance, check out current VA rates and apply with an experienced lender who can discuss the options based on your individual situation and needs.