FHA loan refinances: Requirements, pros and cons

If you’re in the market for a home refinance, you’ll likely discover several FHA loan refinance options. An FHA loan refinance is a solid choice for some homeowners, but not everyone will qualify or benefit from taking this path.

Whether you began with an FHA loan or you’re looking to refinance into one, various possibilities exist. Explore the requirements and the pros and cons of different FHA loan refinance scenarios.

What is an FHA loan?

An FHA loan is a mortgage loan backed by the Federal Housing Administration (FHA). Government-backed mortgages, including FHA loans, offer some advantages over conventional loans.

Thanks to less-stringent requirements, broadly speaking, an FHA loan is often easier for borrowers with a higher debt-to-income ratio (DTI) and a lower credit score to obtain.

How does an FHA refinance work?

When you refinance your mortgage, you’re swapping out your existing home loan for a new one – that likely features different loan conditions.

So, a refinance might be for you if you’re a homeowner looking to lower your interest rate or monthly payment, change your loan type and repayment term, or tap into your home equity.

FHA loan refinance options

If the benefits of a particular FHA loan appeal to you, carefully examine the fine print to determine if you qualify.

1. FHA simple fefinance

An FHA Simple Refinance is a viable option for homeowners who originally purchased their home with an FHA loan. As the name implies, this straightforward refinance option offers homeowners the opportunity to lower their interest rate or their monthly mortgage payment with minimal fuss.

The FHA Simple Refinance can also allow homeowners to switch from an adjustable-rate mortgage (ARM) to a fixed-rate loan.

Refinance requirements

Qualifying for an FHA Simple Refinance means meeting some prerequisites, including credit score requirements and a certain income limit. Typically, a credit score of 580 is necessary to qualify for an FHA Simple Refinance.

Payment history is also considered. For you to be eligible, all your loan payments from the last 6 months must be up to date. A home appraisal will be completed to determine whether your home’s value has changed.

Pros of an FHA simple refinance

Here’s a trio of advantages associated with an FHA Simple Refinance:

• The opportunity to finance closing costs: By lumping your closing costs into the overall loan amount, the upfront costs of refinancing are lower.
• The opportunity to adjust your interest rate: This could mean obtaining a lower rate or switching from an ARM to a fixed-rate loan.
• The opportunity to remove the co-borrower from the mortgage: If you purchased your home with another person who no longer needs to be on the loan, refinancing can offer a chance to remove the co-borrower.

Cons of an FHA simple refinance

Consider these two disadvantages of an FHA Simple Refinance:

• Borrowers can’t take money out. The FHA Simple Refinance option doesn’t come with a cash-out feature, so this isn’t the best option if you’re looking to tap into home equity.
• Borrowers will have to get a home appraisal. You’ll be required to get an appraisal for the purpose of determining your home’s value. This can take time and money and extend the refinancing process.

2. FHA streamline refinance

Much like the Simple Refinance option, the FHA Streamline Refinance is available to homeowners who have an existing FHA loan and are looking to lower their interest rate and monthly payments.

In contrast to the Simple Refinance, the Streamline Refinance may not require an appraisal or an in-depth credit report. As a result, the process should move more quickly.

Refinance requirements

To qualify for an FHA Streamline Refinance, you’ll need an existing FHA loan with no outstanding monthly mortgage payments. You must not be within 210 days of the closing date of your original home loan. Additionally, you’ll have to meet these conditions for your mortgage payments:

• No payments more than 30 days late in the last 6 months
• No more than one payment more than 30 days late within the past 12 months
• At least 6 monthly payments made on your existing mortgage

FHA Streamline Refinances also have a requirement surrounding net tangible benefit, which refers to the financial advantage gained by the borrower with a refinance. This means that for the FHA to approve the refinance, it must be quantifiably beneficial to you as the borrower.

For example, if you’re reducing the length of your loan repayment term, the new interest rate can’t be higher than the rate on the current mortgage. The new monthly mortgage payment also can’t exceed the old payment by more than $50 per month.

Pros of an FHA streamline refinance

Check out these pros of an FHA Streamline Refinance:

• Less strict mortgage lender requirements: Because the refinance is “streamlined,” this process requires fewer in-depth credit and income checks. In general, your lender may assume that if you’re able to pay your current monthly payment, you’ll probably be able to pay the new one.
• No home appraisal requirement: Not having to wait for the home appraisal allows you to close on your refinance faster.
• An option for homeowners who owe more than their home is worth: Even if you owe more on your mortgage than your home’s value, you can still take advantage of this refinance program.

Cons of an FHA streamline refinance

Here’s a summary of FHA Streamline Refinance cons:

• Closing costs that must be paid upfront: Unlike a Simple Refinance, where you can lump closing costs into the loan, an FHA Streamline Refinance requires the borrower to pay closing costs upfront. These costs are typically 2% – 6% of the loan amount.
• A limited cash-out opportunity: This refinancing option allows borrowers to withdraw up to $500 from their home equity.
• Mortgage insurance premiums (MIP): The FHA MIP is required on all FHA loans. If you’re looking to get away from an MIP, refinancing into a conventional loan might be your best option.

3. FHA cash-out refinance

If you’re interested in converting your home equity into cash, an FHA cash-out refinance could be the way to go. The FHA cash-out refinance loan provides homeowners an opportunity to refinance their existing home loan into a new mortgage with a larger loan amount and receive the difference in a lump-sum payment.

Unlike the other FHA refinance options, an FHA cash-out refinance is a viable option for homeowners even if their existing mortgage is a different type of home loan. For example, a homeowner with a conventional loan could opt to refinance with an FHA cash-out refi because the lower credit score requirements make it easier for them to qualify.

Refinance requirements

To qualify for this type of refinance, you’ll need:

• A minimum credit score of 580
• A DTI at or below 43%
• No late mortgage payments during the last 12 months
• Residency in your house for at least 12 months

In addition to these requirements, loan-to-value ratio (LTV) limits are important to keep in mind. These limits control how much equity you need to keep in your home compared with its current value. With a cash-out refi, your LTV ratio can’t exceed 80% of your home’s value – meaning you’ll need to keep at least 20% equity in your home.

Pros of an FHA cash-out refinance

Here are the advantages of an FHA cash-out refinance:

• The potential for lower monthly payments: In addition to tapping into home equity, a cash-out refi could mean obtaining a better interest rate, which could lower your monthly mortgage payments.
• A lump-sum payment you can use for almost anything: From home repairs to debt consolidation and emergency funds, the cash you receive from a cash-out refinance can go toward many projects.

Cons of an FHA cash-out refinance

Check out the downsides of an FHA cash-out refinance:

• An increased loan amount: Cashing out your home equity means taking on additional debt in the form of a higher loan amount. It’s important to consider both the short- and long-term impacts of this decision to determine if it makes sense for you.
• Required MIP payments: If you’re refinancing from a conventional loan into an FHA loan with an FHA cash-out refinance, you’ll be required to pay a mortgage insurance premium.
• A required home appraisal: Unlike a Streamline Refinance, a cash-out refi requires a home appraisal to determine the precise value of the home.

4. FHA 203(k) refinance

Also known as a mortgage rehabilitation or renovation loan, an FHA 203(k) loan refinance allows homeowners to roll home improvement and renovation costs into their home loan.

Two options are available: the limited 203(k) refinance and the standard 203(k) refinance.

• Limited 203(k) refinance: This refinance option lets you borrow up to $35,000 toward qualifying home improvements with no minimum spend. The limited FHA 203(k) refinance only covers uncomplicated surface-level repairs, such as new flooring.
• Standard 203(k) refinance: This FHA 203(k) refinance has no price cap but requires the homeowner to spend at least $5,000 on home projects. The standard option covers major home improvements, such as structural repairs.

Rocket Mortgage® doesn’t offer 203(k) loans.

Refinance requirements

As with the cash-out refinance, you don’t have to begin with an FHA loan to take advantage of an FHA 203(k) refinance. Homeowners with any loan type can leverage this option but will need to meet certain requirements, such as a minimum credit score and a maximum DTI.

A home appraisal will also be required for an FHA 203(k) refinance. It’s important to note that the FHA has specific rules about the types of home improvements that this refinance option will cover.

Pros of an FHA 203(k) refinance

Review a couple of the benefits that come with an FHA 203(k) refinance loan:

• Less-strict credit score requirements: FHA loans often have less-stringent requirements than other types of loans, making it easier for borrowers to get the financing they need when they need it.
• Lower interest rates compared with other home improvement loans: If you have important home repairs and remodels planned, it will likely cost you less in the long run to finance them with an FHA 203(k) loan versus an alternative home improvement loan.

Cons of an FHA 203(k) refinance

Here’s a breakdown of the disadvantages associated with an FHA 203(k) refinance loan:

• The approval process can be longer than with other types of refinances. With many limiting parameters, the process can take more time, and borrowers may experience delays.
• Borrowers can’t use this option for investment properties. Unlike some other refinancing options, the FHA 203(k) refinance can only be used for primary residences.
• Borrowers might have to hire a HUD consultant. Depending on the type of repairs you have planned, the conditions of your loan might require you to consult someone from the Department of Housing and Urban Development (HUD) for approval.

Can homeowners refinance into an FHA loan?

Now it’s time to look at some ways that homeowners can go about refinancing their existing loan into an FHA loan and vice versa.

Can I refinance a conventional loan into an FHA loan?

FHA Simple Refinances and FHA Streamline Refinances are only available to homeowners with an existing FHA loan. But both the FHA cash-out refinance and FHA 203(k) refinance options are available to homeowners with all loan types. This means borrowers can refinance a conventional mortgage into an FHA loan.

Can I refinance an FHA loan into a conventional loan?

It’s possible to refinance an FHA loan into a conventional loan. Homeowners may choose to do this to avoid paying a mortgage insurance premium (MIP), which all FHA loans require for at least 11 years.

With a conventional loan, a different type of mortgage insurance called private mortgage insurance (PMI) is required, but only until you have 20% equity in your home.

Benefits of refinancing an FHA loan

Some of the potential advantages of refinancing an FHA loan include:

• Locking in a lower interest rate: You might be able to score a lower interest rate on your new mortgage, possibly saving you thousands.
• Lowering your monthly payment: Adjusting the rate or repayment term of your mortgage through a refinance can help you lower your monthly payment.

How soon can I refinance an FHA Loan?

The specific amount of time you’re required to live in a home before refinancing varies among the different types of home loans.

With both an FHA Simple Refinance and FHA Streamline Refinance, you’ll need to have lived in the home for 6 months to qualify. Meanwhile, an FHA cash-out refinance requires you to occupy the home for at least 12 months.

The bottom line

If you’re interested in capitalizing on all the benefits of an FHA refinance, you have several options. Consider your short-term and long-term goals alongside the various pros and cons of each refinance program so you’ll choose the one that’s best for you.

Are you ready for an FHA refinance or another refinancing option? Start the approval process today to see how you qualify.