If you currently have a government sponsored loan – such as an FHA loan – you may think that now is a good time to take advantage of the low interest rates and get refinance with a conventional mortgage. There can be many benefits to switching, but keep in mind that you can’t or shouldn’t get refinance just because you want to.
Here are a few things to keep in mind.
You may be able to get rid of mortgage insurance
With an FHA loan, borrowers who deposit less than 20 percent pay two types of mortgage insurance: a one-time upfront mortgage insurance premium and a monthly mortgage insurance payment (MIP), which is required for the life of the loan.
With a traditional loan, borrowers who deposit less than 20 percent are charged an additional monthly fee called personal mortgage insurance (PMI). However, the PMI can be removed once a borrower has reached a mortgage lending value of 80 percent.
“For FHA borrowers with at least 20 percent equity, refinancing to a conventional loan may eliminate that additional mortgage insurance payment,” said Patty Leonard, senior residential loan officer at Independent Bank. “Your lender will likely order a rating to confirm that you have met this threshold, but if you do, you can save a significant amount of money by foregoing mortgage insurance and potentially using a lower interest rate.”
But what if you haven’t quite hit the 20 percent mark yet? Leonard says it might still be worth refinancing into a traditional loan.
“Even if you pay PMI, the benefit is that it eventually drops, which is not possible with an FHA loan,” she said. “But as with any transaction, we need to run the numbers to make sure it’s a smart financial move.”
But you still have to qualify
One big difference between FHA loans and traditional programs is the qualification guidelines. One of the reasons borrowers are drawn to FHA loans is because they allow for lower credit scores.
According to the FHA website, borrowers need at least 580 to qualify for a 3.5 percent down payment loan. Borrowers with a low score of 500 can still qualify with a 10 percent down payment.
To qualify for a conventional loan, you usually need a credit score of at least 620. Borrowers with a score of 740 or higher will usually get the most attractive conventional loan rates. So if you’ve worked improving your credit score over the years, now you may be able to qualify for a conventional mortgage and potentially get yourself a lower interest rate.
However, if you don’t have 20 percent equity and are paying PMI, remember that your creditworthiness is a factor in determining that amount.
“With an FHA loan, the mortgage insurance is all-inclusive,” explains Leonard. “But with a conventional loan, the lower your creditworthiness, the higher your monthly PMI premium. Your creditworthiness may allow you to qualify for a conventional loan, but if it is on the low end you may pay more in PMI and potentially have a slightly higher interest rate. “
Something else to watch out for
Keep in mind that refinancing comes with closing costs that must be paid on completion or included in the loan. As a basic example, if you pay $ 4,000 in refinancing fees and save $ 200 a month on your mortgage, it will take you 20 months to break even. If you are selling your home in the next 1 to 1.5 years, refinancing might not be the best option.
Leonard says her business doubled in 2020 due to historically low interest rates. But while refinance is a great time for many homeowners, this is not the right answer for everyone, and Leonard is open to her clients in this regard.
“I recently met with a homeowner who was interested in refinancing but wanted to sell in the next two years,” she said. “We ran the numbers and it just didn’t make any sense. We could have closed the deal and he would have cut his monthly payment, but in the end he would have lost money on the deal. A reputable lender will ask the right questions and be honest with you and ask your best about trying to get a deal. “
For a list of professional lenders, see the Greater Lansing Association of REALTORS® website at www.lansing-realestate.com.