FHA Refinance: The Complete Guide

FHA refinance can take several forms:

• Streamline refinance with an appraisal.
• Streamline refinance without an appraisal.
• Cash-out FHA refinance.
• FHA-to-conventional refinance.

You can also refinance a conventional (non-government) mortgage to an FHA loan, but that would rarely be the best option. That’s because FHA mortgage insurance is required on every loan regardless of loan-to-value, and it can never be canceled.

The best FHA refinance for you depends on what you hope to achieve by refinancing:

• Reduce your interest rate and/or payment without requalifying.
• Reduce your interest rate and/or payment and wrapping your costs into the new loan.
• Cashing out some home equity.
• Dropping or reducing your mortgage insurance premium.

This guide covers common FHA refinance options, their pros and cons and how they might improve your financial position.

If mortgage rates have fallen since you last financed your home, the easiest way to refinance is the FHA Streamline, also called an FHA-to-FHA refinance.

• Streamline with or without an appraisal.
• No income verification requirement.
• Credit qualification not required.

Why doesn’t the FHA care about your credit, home value or income? Because the federal government is already on the hook if you don’t repay your FHA-backed home loan. So, if a refinance makes it easier for you to honor your obligation, the FHA is on board.

The FHA streamline refinance without an appraisal saves you the cost of an appraisal and perhaps some time in the underwriting process. It’s a good choice if you believe that your property value has fallen since you financed your home. However, some lenders charge more for this loan than they do the option with an appraisal because they believe it’s riskier -- if your home value has not dropped, you might pay less for your loan by getting an appraisal. Check with every lender you contact when shopping for your refinance.

To streamline without an appraisal, you won’t be able to wrap your costs into the new loan -- only refinance the payoff of your old loan. You can choose to pay those costs out of pocket or to go with a so-called “no-cost” refinance, in which the lender increases your interest rate slightly in exchange for covering your financing costs.

If you are refinancing a condominium that has lost its FHA approval, your only option is the streamline without an appraisal.

Streamlining with an appraisal offers a couple of advantages. First, you can wrap your refinancing costs into the new loan if you have enough equity. With FHA upfront mortgage insurance costing 1.75 percent of the loan balance, that’s a significant plus. The other advantage is that an appraisal indicates your property value. And you might find that a conventional (non-government) refinance is possible and cheaper.

The FHA Streamline Refinance imposes these minimum standards for applicants.

• 3 months of on-time mortgage payments.
• At least 210 days since your last refinance.
• There must be a “net tangible benefit”.

“Net tangible benefit” means that the refinance has a valid purpose -- a payment reduction of at least 5 percent, or a .5 percent minimum reduction to your combined loan interest plus annual mortgage insurance premium or replacing an adjustable rate loan with a fixed rate loan. (You will have to requalify if your payment increases by more than 20 percent.)

The bad news is that not all mortgage lenders stick to the official FHA guidelines. Some lenders add credit score minimums or other limitations for FHA Streamline mortgages. These are called “overlays.” The good news is that you can use any lender you want, and many lenders do not have overlays.

You might think that having paid a 1.75 percent upfront mortgage insurance premium (MIP) for your current mortgage that you would not need to pay it again when you streamline refinance. Unfortunately, you would be wrong. You have to pay another upfront MIP in addition to the premium added to your monthly payment.

However, if the FHA loan you’re refinancing is less than three years old, you do get a portion of the MIP already paid refunded to you. The chart below shows the percent of your premium you can get back when you refinance.

FHA cash-out refinancing used to be popular because guidelines allowed borrowers to cash out up to 85 percent of a home’s value. Conventional (non-government) underwriting guidelines only allow cash-out up to 80 percent.

Today, however, FHA follows the same guidelines as conventional mortgage refinance programs. And if you refinance a conventional loan to 80 percent of the property value, you won’t have any mortgage insurance premiums. With FHA mortgages, you always have mortgage insurance. So the only borrowers who can benefit from the FHA program now are those who don’t qualify for less expensive cash-out options.

If you want to cash out home equity and you have an FHA mortgage, apply for a conventional loan first. It’s almost always cheaper. If you don’t get approved, it’s easy enough to change your program and apply for the FHA loan. The lender underwrites your credit, income and home value when you apply for an FHA cash-out refinance.

If you’re considering an FHA mortgage refinance, you should probably look into an FHA-to-conventional refinance first. If you qualify, you might be able to cancel your FHA mortgage insurance. Even if you have less than 20 percent home equity, you will likely qualify for cheaper private mortgage insurance (PMI). And you can request cancelation of PMI once your loan balance drops below 80 percent of your property value.

If you want to refinance your FHA mortgage to get better terms or cash out, start with a conventional mortgage application. You fill out the same application that you’d do for an FHA loan. Your lender submits it for automated underwriting in most cases, and you get a decision in minutes. If you get approved, you can choose the cheaper, better loan. If you get denied, you still have the option of the streamlines loan with or without an appraisal.