Whether you opted for an FHA loan because you wanted to make a lower down payment or because you needed easier credit standards, you may be considering refinancing your home. While a good lender can help you evaluate your individual circumstances, there are steps you can take first to make the most of an FHA refinance.
First, you should be aware that the mortgage insurance premiums on FHA loans, which are required of all borrowers for at least 11 years and sometimes for the entire loan, have been raised several times in the past few years. Refinancing into a new FHA loan may or may not save money on your monthly payments depending on the difference in your interest rate and the amount you currently pay in mortgage insurance. Of course, depending on how long you've been paying your current loan, you may be refinancing a much smaller balance than your initial loan, which will also reduce the size of your monthly payments.
Tips that make an FHA refinance easier
You'll need to consult a lender, but first follow these steps to prepare for an FHA refinance:
1. Check your credit. Before you start shopping for a new FHA loan, check your credit report and your credit score. FHA lenders typically require a credit score of 620 or 640 or above, but some have higher standards. If you need to fix an error or take steps to boost your score, it could take a few months or longer, so it's best to start this process as early as possible.
2. Check your home's value. FHA loans can be refinanced with a loan-to-value of as high as 97.5 percent, but in some areas of the country home values have not recovered from the low point after the housing bubble burst. A realtor can give you an idea of local home prices for comparable homes.
3. Evaluate your debt-to-income ratio. You'll need a debt-to-income ratio of a maximum of 41 to 43 percent, depending on the lender. The ratio will depend on the size of your new mortgage payment, but you can get a rough idea of that payment with a mortgage calculator. You may need to pay off some debt to qualify for an FHA refinance.
4. Compare loan terms. FHA loans are available as adjustable rate loans and as fixed-rate loans with 15- and 30-year terms. If you currently have a 30-year FHA loan, check the monthly payments on a shorter loan term to see if you can comfortably afford the payments. You'll save thousands in interest over the life of the loans even though your payments could be higher.
5. Compare FHA and conventional loans. You should ask your lender to compare the potential terms of a conventional loan along with an FHA refinance. A conventional mortgage will require private mortgage insurance if you have less than 20 percent in home equity, but it may be less costly than FHA mortgage insurance. However, FHA mortgage rates are typically a little lower than conventional mortgage rates, so you'll need a lender to get an accurate comparison of your loan options.
Taking the time to prepare for FHA refinancing can help you make the best decision for your finances.