Can You Refinance FHA Loans to Conventional Loans?

by Don Rafner

    Loans insured by the Federal Housing Administration are popular because they require homeowners to come up with a down payment of only 3.5 percent of a home's final purchase price. Most conventional mortgage loans require down payments of at least 5 percent, which that can add thousands of dollars to a down payment. But FHA loans come with a disadvantage, too. If you're paying one off, you'll be required to carry mortgage insurance for a set number of years, something that can add to the size of your monthly mortgage payment. Fortunately, you can refinance an FHA loan to a conventional loan. You just have to have enough equity in your home.

    Mortgage Insurance

    Mortgage insurers require that borrowers take out private mortgage insurance -- a form of financial protection for lenders, not borrowers -- if the amount they owe on their mortgage loan is more than 78 percent of their home's value. Borrowers who owe $180,000 on a home valued at $200,000 would need mortgage insurance because the amount they owe on their mortgage loan is 90 percent. The cost of private mortgage insurance varies, but you can expect to pay an annual premium of 1 percent to 2 percent of the amount you owe on your mortgage loan. For a loan of $200,000, you'd pay from $2,000 to $4,000 a year, or from about $166 to about $333 a month. Conventional mortgage loans, including those backed by Fannie Mae or Freddie Mac, allow borrowers to drop private mortgage insurance once the amount they owe on their loans drops to 78 percent of their home's value. FHA-backed loans require that owners keep making mortgage insurance payments even if their loan-to-value ratio falls to that 78 percent level.

    FHA Mortgage Insurance Premium

    FHA loans require their own mortgage insurance, the FHA mortgage insurance premium. This premium includes an up-front fee of 1 percent to 1.75 percent of a loan's principal balance at closing. Borrowers must also pay an annual premium that ranges from 1.15 percent to 1.25 percent of the principal balance of their loan. For a loan with a $200,000 balance, that comes to $2,300 to $2,500 each year. Unlike standard private mortgage insurance, borrowers can't automatically drop this insurance if their loan-to-value ratio falls to 78 percent. The FHA mortgage insurance premium is a required payment for the life of the loan. This means that some borrowers who owe 78 percent or less of their home's current value would see their payments drop if they refinanced from an FHA loan to a conventional one.

    Refinancing

    The good news is that refinancing an FHA loan into a conventional one works much like any other refinance. Borrowers should contact several mortgage lenders licensed to do business in their state so that they can compare rates and fees. Once borrowers find a lender they like, they'll have to fill out a Uniform Residential Loan Application to start the refinance process. Borrowers will also have to provide their lender with proof of income. They can do this by sending copies of their last two months of bank account statements, last two years of income-tax return statements and last two paycheck stubs. They'll also have to give their lender permission to run their credit report.

    Equity

    Most lenders require that borrowers have at least 20 percent equity in their homes for a conventional refinance. This can be a challenge for borrowers whose original loans are insured by the FHA. Because the FHA does not require as large a down payment, these borrowers might not have paid off as much of their mortgage loans by the time they want to refinance, making it more difficult for them to reach that required 20-percent-equity level. If borrowers have seen their home's value stagnant or drop since they purchased it, they might even have no or negative equity in their homes.

    About the Author

    Don Rafner has been writing professionally since 1992, with work published in "The Washington Post," "Chicago Tribune," "Phoenix Magazine" and several trade magazines. He is also the managing editor of "Midwest Real Estate News." He specializes in writing about mortgage lending, personal finance, business and real-estate topics. He holds a Bachelor of Arts in journalism from the University of Illinois.