FHA refinance vs. conventional refinance: Which is better?

Eager to refinance your mortgage loan and take advantage of lower rates, a different repayment term, or the chance to get rid of mortgage insurance? Indeed, there are many good reasons to pull the trigger on a refi when the time is right. But if you have an FHA loan or a conventional mortgage, you may be wondering: Is it worth refinancing from FHA to conventional, or vice versa? What are the refinance costs? Should I pursue a no-closing-cost refinance? And how long does it take to refinance in general?

Read on to learn more about the pros and cons of an FHA refinance versus conventional refinance and when it pays to switch loan types if you want to reset your mortgage.

What is an FHA refinance?

An FHA loan is a type of mortgage financing backed by the government – in this case, a loan insured by the Federal Housing Administration (FHA). This loan is intended to make homeownership more accessible for borrowers who may not qualify for conventional loans.

Refinancing your FHA loan involves replacing your existing mortgage with a new one, ideally with a different interest rate, term, or repayment options. Borrowers often pursue an FHA refinance to lower their monthly payments, change from an adjustable-rate to a fixed-rate mortgage, or access their home equity.

“FHA loans are especially popular because FHA guidelines allow lower credit scores and higher debt-to-income ratios than conventional loans,” says Dayton, Ohio-based REALTOR® Ryan Ingram.

There are several FHA refinance programs available to choose from, including an FHA cash-out refi (covered next). The FHA Simple Refinance is a straightforward option if you already have an FHA loan and want to reduce your payment or rate, while the FHA Streamline Refinance simplifies the process by requiring less documentation and, in some cases, no home appraisal.

What is an FHA refinance vs. FHA cash-out?

If you desire to convert your home equity into dollars, an FHA cash-out refinance provides an opportunity to refinance into a larger loan and receive the difference in cash. This option can be used for various purposes, such as home improvements or debt consolidation. Additionally, you can pursue an FHA cash-out refinance even if you currently do not have an FHA loan – so long as you meet FHA eligibility requirements. But keep in mind that this refinance increases your total loan amount and requires paying mortgage insurance, so it’s important to carefully consider the long-term financial implications before committing.

What is a conventional refinance?

Conventional loans, on the other hand, are mortgages offered by private lenders without government insurance or guarantees, unlike FHA loans. They come with more risks to lenders, so these mortgages commonly require a lower debt-to-income ratio, higher credit score, and bigger down payment to qualify.

Rate-and-term vs. cash-out

A rate-and-term refinance enables you to change your existing mortgage’s interest rate and term. Decreasing your interest rate can drop your monthly payment, but it could lengthen your loan term. Shortening your term, on the other hand, can lead to a higher monthly payment but save you on total interest paid over the life of the loan.

With a cash-out refi, you take out a new mortgage loan for a bigger amount and pocket the difference between the old and new loan amounts in cash you receive at closing.

Key differences at a glance

Here’s a quick breakdown that briefly explains the major distinctions between a conventional refi versus FHA refi:

 “FHA rates are often slightly lower than conventional rates, but the total cost can be higher once you factor in the mortgage insurance premium required. Conventional loans may carry higher interest rates but save money long-term if you have equity accrued,” adds Ingram. “Also, consider that FHA loans allow for lower credit and higher DTI ratios, while conventional refinance loans favor stronger credit and lower LTV ratios. And while an appraisal may be required for either option, FHA appraisals are more condition-focused, while conventional appraisals are value-focused.”

FHA vs. conventional refinance: Side-by-side comparison

Now, let’s take a deeper dive into the advantages and disadvantages, as well as loan limits and property type considerations, for an FHA refinance versus a conventional refinance.

Pros and cons of an FHA refinance

If you already have an FHA loan, you know that you have to pay a mortgage insurance premium (MIP), no matter how large a down payment you made. The MIP includes an up-front amount due at closing as well as a yearly amount added to your monthly payments. If you made a down payment of at least 10%, the MIP will go away after 11 years; if not, the MIP stays in place for the life of your loan. Hence, one of the biggest advantages of refinancing from an FHA loan to a new conventional refinance loan is the ability to eliminate the MIP.

Truth is, conventional loans may require paying a similar insurance – called private mortgage insurance (PMI) – if you have accrued less than 20% equity; still, this total cost can often be less than what you would pay if you had an FHA MIP. Keep in mind that if you refinance your FHA loan to a new FHA loan, you will still have to pay the MIP (although, if you refinance within 3 years of your original loan, you may qualify for a partial refund of the upfront MIP you already paid).

Of course, another major upside of refinancing your FHA loan – whether it’s to a new conventional or new FHA refinance mortgage – is that you could save big money otherwise spent on total interest if you can lock in a lower interest rate and/or shorten your loan’s term. Or, if you want to make monthly payments more manageable, refinancing to a longer term can help (although you will pay more in total interest).

Then again, refinancing your FHA loan will involve costly closing expenses, which often equate to 3% to 6% of your remaining loan balance. That’s why it’s smart to crunch the numbers and calculate your breakeven point to decide if the savings generated by this move offset the upfront costs involved. Another drawback of refinancing is that you have to repeat the entire mortgage approval process, which can be time-consuming and tedious: You’ll be required to get your home reappraised and submit necessary documentation like tax returns, pay stubs, and proof of insurance. There’s also the risk of refinance remorse, which can happen if you close on your refinance loan but soon learn that interest rates have dropped even farther. You can always opt to refinance down the road, but you’ll have to pay closing costs all over again, and there may be a minimum waiting period involved (often 6 months or longer).

“FHA loans may offer a lower interest rate than conventional loans. But the required mortgage insurance premiums often make the total APR cost higher than a conventional loan for well-qualified borrowers,” says Martin Boonzaayer, CEO of The Trusted Home Buyer. “Credit, DTI, and LTV rules are looser for FHA but stricter for conventional loans, while the opposite is true of appraisal requirements.”

Pros and cons of a conventional refinance

Refinancing your conventional mortgage can help you meet your financial objectives more quickly because you can change your interest rate and/or loan term. Case in point: If your goal is to own your home outright sooner after already making several years of payments on a 30-year loan, you might want to refinance into a new 15-year mortgage loan. This will enable you to pay off your principal faster, accrue equity more quickly, and get rid of monthly mortgage payments years earlier than originally scheduled. Along this new journey, you’ll likely save thousands in interest, particularly if mortgage refi rates are less than the rate you’re already paying.

Alternatively, you can opt to pay less every month by choosing a new loan with a longer term. This strategy, coupled with the lock-in of a lower refi interest rate, can make monthly payments a lot more affordable.

Another good reason to refinance is if you have an adjustable-rate mortgage (ARM) and the rates have increased; by replacing that ARM with a fixed-rate mortgage, you can ensure predictable payments and safeguard your finances from future rate increases.

Let’s say you need extra cash to fund a home improvement project, consolidate debt, or make a major purchase. Choosing a cash-out refinance will let you tap into your home’s accrued equity and cash it out at closing.

But resetting your conventional loan has its downsides, too. Remember that you have to pay closing expenses that amount to several thousand dollars. As is true with an FHA refinance, take the time to determine your break-even point. If you anticipate moving or selling your home before reaching this milestone, you could end up in the red instead of the black when it comes to recouping your closing costs. Also, the refi process takes time and a lot of paperwork.

What’s more, your monthly payment could increase based on the type of refinance you pick. If, for instance, you move to a shorter-term mortgage, your monthly payment will almost certainly go up. And pursuing a cash-out refinance will decrease your home equity position, meaning you will own less of your property and have less equity ready for future tapping or financial flexibility.

“Conventional refinances have stricter qualification rules than FHA refinances. But their major benefit is the ability to cancel private mortgage insurance – if applicable – once you reach a 20% equity position. And conventional loans can also be used for secondary homes and investment properties and generally have higher loan limits as well,” says Boonzaayer.

Loan limits and property type considerations

Be aware that there are loan limit rules you’ll have to follow when refinancing a conventional or FHA mortgage. FHA loan limits will differ based on county and type of property. Currently, the single-family home baseline limit for any type of FHA refinance is approximately $524,225, although that ceiling can go up to $1,209,750 in high-cost areas.

Meanwhile, Freddie Mac and Fannie Mae set conforming loan limits for conventional loans: Currently, the baseline limit is $806,500 for a single-family home, although higher ceilings are allowed in costlier markets. If you want to refinance beyond these maximums, you’ll need a nonconforming or jumbo loan, which typically has more stringent down payment and credit requirements.

With a conventional loan, you’re allowed to refinance primary residences as well as second homes and investment properties – although nonconforming/jumbo restrictions may come into play with multiunit or larger properties. With an FHA loan, you can refinance an owner-occupied property of one to four units (so long as you, the borrower, occupy one of the units). Condos, certain manufactured homes, and planned unit developments (PUDs) may also be eligible for conventional or FHA refinancing if the property fits particular lender and agency requirements.

When it makes sense to switch from FHA to conventional or another FHA

It can be a good idea to swap out your FHA mortgage for a new conventional refinance loan under particular scenarios.

“Switching to a conventional refinance is smart if your financial profile is strong, particularly if you have 20% or more equity and a good credit score of higher than 620; but a score of 700 or higher is ideal,” says Boonzaayer.

Ingram points to another benefit.

“Making this switch will eliminate the lifetime FHA mortgage insurance premium and can reduce your overall payment significantly,” he says.

But again, it pays to do a break-even analysis whereby you compare the closing cost fees versus your monthly savings to more accurately determine if switching from an FHA to a new conventional refinance mortgage is your best bet.

Or, you could refinance into a new FHA refinance loan, which can be beneficial if you need flexible qualification standards.

“If you are currently in an FHA loan, the FHA Streamline is a simple, low-cost way to reduce your rate,” adds Boonzaayer. The latter requires minimal documentation, no appraisal in some cases, and no income verification. It’s ideal if your objective is to simply reduce your monthly payment or interest rate.

Shirshikov agrees, noting that “refinancing from an existing FHA to a new FHA loan is frequently more accessible if you have less of a credit history and/or lower credit scores – typically between 580 and 620.”

When it makes sense to switch from conventional to FHA

If you currently have a conventional mortgage loan, don’t overlook the option of switching to a new FHA refinance mortgage.

“But consider this option only if your credit has slipped or your DTI has increased beyond what conventional limits allow, and if you cannot qualify for a new conventional loan. The FHA’s underwriting is more flexible, but you will have to pay an upfront mortgage insurance premium as well as annual MIP,” cautions Ryann Brier, a western Michigan-based REALTOR® and real estate investor.

Closing costs and what they cover

As mentioned earlier, you’ll probably pay between 3% and 6% in closing expenses when you refinance your loan. This typically covers the following costs:

• Home appraisal (if the lender requires it), which determines your property’s current value
• Title searches and title insurance to ensure there are no claims or liens on your property
• Lender fees for processing and underwriting your new mortgage
• Escrow funds to cover homeowners insurance, mortgage insurance, property taxes, and other charges (if applicable)
• Mortgage discount points, which enable you to decrease your interest rate by paying up front
• Prepaid interest and tax monitoring fees
• Other various fees, including attorney fees, courier fees for document delivery, and land survey fees (if required by your state)

“Refinancing to a new FHA loan will also come with an upfront mortgage insurance premium of 1.75%, which can be rolled into your loan. Refinancing to a new conventional mortgage will avoid the MIP, but you may be on the hook for private mortgage insurance if your equity is below 20%,” Boonzaayer says.

These expenses will be paid at your refinance closing meeting out-of-pocket, typically via a bank account.

No-closing-cost refinance trade-offs

Or, you can choose a no-closing-cost refinance. This works by rolling your closing costs into your new refinance loan and adding these expenses to your new mortgage balance. Consequently, your total loan amount and monthly payments will be a bit higher. Alternatively, your lender may cover all of these fees for you if you choose a slightly higher interest rate. Just keep in mind that you will probably pay more over the life of your loan in the form of higher interest than if you had simply paid the closing costs up front out-of-pocket.

How to refinance from FHA to conventional (step-by-step)

Whether you want to refinance from an existing FHA or conventional mortgage to a new FHA or conventional loan, the steps involved are usually the same:

1. Determine your goals. Are you seeking to decrease your monthly payment, lower your rate of interest, or liquidate home equity via a cash-out refinance? By carefully assessing your objectives, you can narrow down the type of refinance loan and loan program that’s best for you.
2. Check your credit, LTV, equity, and DTI. You’ll want to gauge your current credit score, debt-to-income (DTI) ratio, loan-to-value (LTV) ratio, and the amount of equity you have accrued in your property. Knowing these numbers can help you pick the right refinance program you are more likely to qualify for. Your bank or credit card company can likely provide your free credit score. To calculate DTI, add up all your monthly debt payments and divide that by your gross monthly income. Calculate your LTV by dividing your existing mortgage balance by your property’s appraised value. Determine equity by subtracting what you still owe on your loan from your home’s current market value.
3. Shop around among several different lenders and compare loan estimates carefully. By comparing loan offers and total costs from at least a handful of lenders, you’ll likely find a better deal.
4. Submit your refi application. Narrow down your list of lenders to one and formally submit a refinance loan application. Be prepared to furnish essential paperwork like recent pay stubs, bank statements, and W-2s. If you are self-employed, you may need to submit extra documentation.
5. Lock in the interest rate. Following the processing of your application, your lender will deliver a loan estimate that details the expenses, fees, and terms for your new mortgage refinance loan. Locking in your interest rate can safeguard against rates going higher in the near future. Note that most rate locks last between 15 and 60 days, although you may be able to pay a higher fee for a longer lock.
6. Have your home appraised. Your lender will likely require a professional appraisal of your property that you will have to pay for. This process makes sure your loan amount does not exceed your property’s worth.
7. Await an underwriting decision. The lender’s underwriting team will carefully evaluate your earnings, assets, and overall eligibility and render a lending decision within days or a few weeks.
8. Close on the loan. Your lender will set a date for closing. On that date, you will sign crucial paperwork and pay any closing costs involved. An attorney, escrow agent, or other neutral third party will finalize your refinance. This is when your existing mortgage loan will be paid off and your new refinance loan will go into effect.

Timing and Eligibility

You may be required to wait a minimum time after closing on your existing mortgage loan before you can refinance. Often, this wait period is at least 6 months for an FHA or conventional rate-and-term refinance loan. They want to be sure you’ve established a sufficient payment history and your loan has amortized. But your lender may make you wait at least 12 months before they will allow a cash-out refinance unless you demonstrate more favorable credit and home equity numbers.

“Many loan programs require at least six on-time loan payments made before you can refinance. An FHA Streamline refinance also requires 210 days from the prior closing,” says Brier.

Alternatives if you don’t switch

Refinancing to a new FHA or conventional loan isn’t your only option here, depending on your goals. Instead, especially if you don’t qualify for your desired refinance option, consider these alternatives:

• Try to qualify for a USDA or VA refinance loan. For the former, your property must be located in an eligible rural location, it must be your primary residence, and you must meet strict income limits. You can only qualify for a VA refinance loan if you are now a veteran, active-duty military member, or surviving spouse; if so, you can pursue either a VA IRRRL to lower your interest rate or a VA cash-out refinance to replace a non-VA loan. Both loan programs may require income verification, a home appraisal, and other documentation.
• Pursue a home equity financing product. If you need extra funds and want to tap equity, consider a home equity loan or home equity line of credit (HELOC). Rocket Mortgage does not offer HELOCs at this time, but we do offer a Home Equity Loan.
• Change your loan payments. If you desire to pay down your mortgage more quickly and decrease total interest costs, you can shorten your loan’s term by making accelerated payments applied toward your principal.
• Inquire about loan modification. Having trouble making payments or want to lower your monthly mortgage payments? Ask your lender if it’s possible to alter your existing loan terms, which may include extending the term, decreasing the interest rate, or lowering payments temporarily if they allow it.
• Sell your property. If you don’t like your existing loan’s terms or rate and feel stuck, you may want to consider listing your home for sale and perhaps buying a new property that could provide better access to more preferred financing.

The bottom line: Your refinance choice depends on your situation

Many experts recommend switching from an existing FHA mortgage to a conventional refinance if you qualify and if doing so won’t increase your total monthly payment or long-term interest costs. A conventional refinance can allow you to eliminate the mortgage insurance premiums required for the life of your FHA loan. In most cases, you’ll need at least 20% equity in your home and a credit score of 620 or higher to be eligible. However, if your credit or debt-to-income ratio is less than ideal and you want to keep your cash flow tight, it may be worth refinancing into a new FHA loan instead.

If you’re considering refinancing your current loan, get in touch with the Home Loan Experts at Rocket Mortgage to go over your options.

The FHA Streamline program may have stricter requirements in some states. In order to qualify for the FHA Streamline program, an immediate .5% minimum reduction in interest and mortgage insurance premium is required. Some states may require an appraisal.

Rocket Mortgage is not acting on behalf of FHA or HUD.

Refinancing may increase finance charges over the life of the loan.

To qualify for this offer, you must meet all standard FHA eligibility requirements. In addition, your total mortgage payment, including taxes and insurance, cannot exceed 38% of your income, your debt-to-income (DTI) ratio cannot exceed 45%, and you must have 12 months of verifiable housing history immediately prior to your application, no late payments 30 days or greater in the last 12-months, and no derogatory marks on your credit report. Not available on jumbo loans. Asset statements may be needed, no more than 1 day of non-sufficient fund fees are allowed in the most recent 2 months prior to application. Additional restrictions/conditions may apply.

Rocket Mortgage is a VA-approved lender, not endorsed or sponsored by the Dept. of Veterans Affairs or any government agency.

The VA Streamline program may have stricter requirements in some states. In order to qualify for the VA Streamline program, you must have a VA loan. The VA Streamline is only available on primary residences. Cash-out transactions are not allowed. In order to qualify for a VA Streamline, a 0.5% minimum reduction in interest rate on the previous fixed-rate loan must occur if the new loan will be a fixed rate or a 2% minimum reduction in interest rate on previous adjustable rate mortgage loan must occur; a minimum of 6 months of consecutive mortgage payments must be paid on the current loan at the time of application. Some states may require an appraisal. Additional restrictions/conditions may apply.

Home Equity Loan product requires full documentation of income and assets, credit score and max loan-to-value (LTV), combined loan-to-value (CLTV), and home equity combined loan-to-value (HCLTV) ratios. Requirements were updated 2/5/2024 and are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 80%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 740 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 50% or below. Valid for loan amounts between $45,000.00 and $500,000.00 (minimum loan amount for properties located in Michigan is $10,000.00). Product is a second standalone lien and may not be used for piggyback transactions. Product not available on Schwab products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “higher priced” based on the APOR spread test. Higher priced loans are not allowed on properties located in New York. Additional restrictions apply. Not available in Texas. This is not a commitment to lend.