For many first-time buyers, a Federal Housing Administration (FHA) loan is the prudent—and often the only—choice for a mortgage. With the flexible credit and low down payment requirements, an FHA loan makes it easier to qualify than almost any loan out there.
However, the ongoing private mortgage insurance (PMI) you have to pay when you have an FHA loan makes your monthly payments more expensive. And, unlike a conventional loan, which allows you to remove your PMI at a certain point, you can never get rid of it with an FHA loan—even when you have tons of equity in your home. So, with rates at historic lows, should you refi out of your FHA loan to a conventional loan? We’re looking at the pros and cons.
Pro: You can get rid of private mortgage insurance (PMI)
“FHA loans require certain provisions which sometimes place a heavy burden on a homeowner’s budget, often in the form of premiums paid for mortgage insurance,” said PennyMac.
That mortgage insurance on an FHA loan ranges from .45–1.05% of your home loan amount every year. On a $285,000 home, “families could be spending more like $3,420 per year on the insurance,” said Investopedia. “That’s as much as a small car payment!”
That money is literally insurance for the lender in case you default on your loan. And, unfortunately, they continue to collect that insurance regardless of how far you pay down your mortgage balance or how much your home appreciates.
“To stop paying PMI on an FHA loan you will need to refinance into a conventional mortgage,” said The Lenders Network.
The solution: refinance to a conventional loan. Assuming you have enough equity in your home, you won’t have to pay mortgage insurance on the new loan. Combined with a lower rate, your monthly payment will drop. “If you have paid down the loan to 78% of the value of the home you can refinance into a conventional mortgage without having to pay PMI.”
Pro: Mortgage insurance for conventional loans may be less expensive
If you refi to a conventional loan and still have to pay mortgage insurance because you don’t yet have enough equity in your home, you may be able to benefit from the lower payments.
“The mortgage insurance fee on a conventional loan is lower than it is with FHA. FHA MIP rates are 0.80% – 1.00%,” said The Lenders Network. “Many conventional mortgages have an annual PMI fee of 0.50%. On a $200,000 home that is savings of almost $80 per month. While it is not a huge savings, the PMI will drop off once the LTV reaches 78%. After dropping PMI, the savings is almost $2,000 per year. You can generally refinance out of FHA into a conventional mortgage after 6 months.”
With any refi, you’re going to pay closing costs. When you’re refinancing out of an FHA loan into a conventional loan, you can count on those costs ranging from about 1.5% to as much as 3%. So, on a $300,000 mortgage, you’re looking at about $9,000. There may be a few out-of-pocket costs involved in the process; Typically, you’ll be responsible for paying for an appraisal. The rest of the closing costs will come from your equity.
When you’re trying to decide whether or not to refinance, look at the cost to you, and determine how long it will take to recoup the money with your lower payment. If you won’t break even for seven years and you’re planning on moving in three, perhaps it’s time to reconsider whether you should refinance at all.