Refinance is the route you take when you want to make your mortgage debt easier to repay, more affordable in the long run. But with an array of refi options available in the market, it can be a challenge to go through every possible refinance program. For the interest of borrowers and would-be refinancers, we will discuss two stand-out refinance programs: conventional and FHA refinance programs and weigh their merits and downsides.
In the hopes of making a meaningful comparison, let’s focus on three main points and see what each refinance option has to offer:
- Mortgage Rates
- Mortgage Insurance
- Mortgage Refi Options
FHA: More Forgiving Refinance Option
The Federal Housing Administration insures mortgages made to borrowers with less-than-stellar credit. FHA loans accept credit scores of 580 and below. They are also more lenient, requiring lesser waiting periods for those with dings in their credit reports like bankruptcy, foreclosure, and short sale.
In terms of mortgage rates, FHA refi loans can offer competitive, low rates as that of their conventional loan counterparts. FHA refinance rates are hinged on credit scores, current market conditions, and other factors. And although a poor credit might land you a higher rate, still, FHA loans are more forgiving in their qualification criteria than conventional loans.
When you refinance to an FHA loan, you’ll pay a mortgage insurance that basically protects lenders from loss caused by foreclosure. This comes in two-folds:
- an upfront fee called Upfront Mortgage Insurance Premium that is equivalent to 1.75% of the total loan amount. The UPMIP is collected at closing but can be financed into the total mortgage amount.
- an annual insurance premium, which is basically a periodic mortgage insurance premium collected every month, whose rate depends on the base loan amount, LTV and loan duration.
Mortgage insurance associated with FHA loans have to be paid for five years and sometimes throughout the life of the loan. This can be expensive in the long run; although, it is possible to cancel or terminate FHA MIP, subject to fulfilling the agency’s conditions.
Moreover, the FHA has a number of refinance options available for FHA and non-FHA loans, such as:
- FHA No Cash-Out Refinance. This refers to FHA Streamline Refinance, which offers an FHA-to-FHA refinance and requires less paperwork and documentation. An appraisal is not required, allowing current homeowners to refinance their underwater mortgages. Another no-cash out refinance is the traditional rate and term refinance, which allows a non-FHA loan to be replaced with an FHA-insured loan. LTV limit is 97.75%.
- FHA Cash-Out Refinance allows homeowners with FHA and non-FHA loans to take out cash out of their equity. This refi option requires an 85% loan-to-value ratio.
- FHA Short Refinance helps non-FHA loan homeowners refinance to align their current debt with their home’s current market value.
Conventional: More Affordable Refinance Option
Conventional mortgages are those not insured by any government entity and conform to the loan limits and other criteria set by GSEs, Fannie Mae and Freddie Mac. That being said, conventional loans have more stringent qualifying credit and mortgage criteria.
Just like FHA refinance rates, conventional mortgage rates are also affected by credit scores, market rates and more. As conventional mortgages don’t carry any government guarantee, their rates may be higher than FHA loans. The catch is, these costs may be offset by the lack or elimination of private mortgage insurance (PMI).
You see, conventional mortgages don’t require PMI when:
- You make a 20% down payment, and
- You have 20% equity in your home.
And if you do end up paying PMI, it can be eliminated once your mortgage reaches certain LTV limits, e.g. usually when your mortgage balance drops below 80% of the purchase price of the home or the appraised value of the property. This event lowers the monthly mortgage payment and thus makes it more affordable to repay in the long run.
In terms of refinancing options, conventional mortgages have:
-
HARP® or Home Affordable Refinance Program® is like a streamline refinance program for loans owned by Fannie Mae or Freddie Mac. It allows homeowners to refinance their mortgages regardless of LTV.
- Cash-Out Refinance allows conventional loan homeowners tap their equity and take cash out at closing. Conventional lenders can allow a cash-out refinance of up to 80% LTV.
So, Which Is The Better Option?
In terms of affordability, a conventional refinance wins but entails tougher requirements to qualify. FHA loans, on the other hand, may be more expensive because of the PMI but they have easier-to-qualify guidelines and possibly lower rates.
Accordingly:
- Opt for an FHA refinance if your credit is not good or has been damaged and the value of your home has deteriorated.
- Opt for a conventional refinance if you own 20% equity and don’t like to pay any PMI and require a loan higher than FHA loan limits.
