How to Refinance From an FHA to a Conventional Loan

Refinancing an existing FHA loan to a conventional mortgage can be a strategic financial decision for many homeowners. This process involves replacing your current government-backed FHA loan with a new loan that adheres to conventional lending standards. Understanding the eligibility criteria and associated costs is important for those considering this change.

Understanding the Shift from FHA to Conventional

FHA loans are insured by the Federal Housing Administration, allowing lenders to offer more lenient qualification criteria, such as lower credit score requirements and smaller down payments. A notable aspect of FHA loans is the requirement for mortgage insurance premiums (MIP). This includes an upfront premium, typically 1.75% of the loan amount, and annual premiums paid monthly. For most FHA loans originated after June 2013, this annual MIP remains for the life of the loan, regardless of the borrower’s equity.

Conversely, conventional loans are not government-insured and generally have stricter underwriting requirements. A key advantage of a conventional loan is the flexibility regarding mortgage insurance. If a borrower has at least 20% equity, private mortgage insurance (PMI) is not required. If less than 20% equity exists, PMI is typically required, but it can be canceled once the loan-to-value (LTV) ratio reaches 80% or below, or when equity reaches 22% of the original value. This distinction often motivates homeowners with FHA loans to refinance into conventional loans once they have built sufficient equity.

Borrower and Property Eligibility

To qualify for a conventional refinance, both the borrower and the property must meet specific criteria. Borrower eligibility involves a higher credit score than required for an FHA loan, typically a minimum of 620. A higher score can lead to more favorable interest rates. Lenders also evaluate the borrower’s debt-to-income (DTI) ratio, comparing monthly debt payments to gross monthly income. While some lenders may allow a DTI up to 50%, a ratio below 43% is often preferred. A stable employment history, typically two years in the same job or industry, is also a common requirement.

Property eligibility focuses on the home’s equity and condition. To avoid paying PMI on a conventional loan, a borrower generally needs at least 20% equity. For example, if a home is valued at $300,000, the outstanding mortgage should be $240,000 or less. Even with less than 20% equity, refinancing may be possible with PMI, but many aim for the 20% threshold to eliminate this cost. Property condition is assessed through an appraisal, which determines the home’s market value and ensures it meets conventional lending standards. Unlike FHA loans, conventional loans typically have less stringent property requirements, focusing on structural integrity and marketability rather than minor cosmetic issues.

Necessary Financial Documentation

Gathering specific financial documents is a fundamental step for a conventional refinance. Lenders require proof of income to assess repayment capacity. This typically includes pay stubs covering the most recent 30 days and W-2 forms from the previous two years. Self-employed individuals need to provide federal tax returns for the past two years, along with profit-and-loss statements.

Asset verification is also required to confirm available funds for closing costs and reserves. This involves providing bank statements for checking and savings accounts, usually for the most recent two months. Statements for investment and retirement accounts may also be requested. Proof of identity and residency, such as a valid photo ID, is necessary. Borrowers must also supply existing mortgage statements for the property being refinanced, homeowner’s insurance declarations pages, and property tax statements.

Navigating the Application and Closing Process

The process of applying for and closing a conventional refinance involves several distinct stages. Borrowers should research and select a lender offering competitive rates and terms. Once a lender is chosen, the formal application process begins, submitting the gathered financial documentation. This allows the lender to verify income, assets, and financial stability.

Following application submission, the loan moves into the underwriting phase. An underwriter reviews all submitted documents to assess risk and ensure compliance with lending guidelines. This includes examining credit history, debt-to-income ratios, and employment verification. An appraisal of the property will be ordered to confirm its market value and condition. Upon successful completion of underwriting and appraisal, the loan is approved. The final stage is closing, where all necessary legal documents are signed, and funds are disbursed to pay off the existing FHA loan, officially replacing it with the new conventional mortgage.

Associated Refinance Costs

Refinancing a mortgage, including the transition from an FHA to a conventional loan, involves various costs. These expenses, commonly referred to as closing costs, typically range from 2% to 6% of the new loan amount. These costs encompass a range of fees, some paid to the lender and others to third-party service providers.

Lender fees may include an origination fee for processing the loan, and an underwriting fee. Third-party fees often include appraisal fees for determining the property’s value, and title insurance, protecting both the lender and homeowner against future claims to the property’s title. Other potential costs include attorney fees, credit report fees, and recording fees. Additionally, prepaid expenses, such as property taxes and homeowner’s insurance premiums for a certain period, are often collected at closing. These costs can be paid out-of-pocket, or in some cases, rolled into the new loan amount, increasing the principal balance. Some lenders may also offer “no-closing-cost” refinance options, where fees are covered in exchange for a slightly higher interest rate.