You took an FHA loan because of the low down payment requirements and/or the flexible underwriting requirements. Now you are toying with the idea of refinancing. When does it make sense to do so?
The answer is that it depends on your situation. Are you in the home for the loan term? You may want to consider refinancing into a conventional loan, but you’ll have to time it correctly. If you aren’t staying in the home for the long-term, or you don’t have good qualifying factors, an FHA refinance may be the better option. Sometimes it makes sense to just do nothing at all.
Ask yourself the following questions to determine the right time to refinance your FHA loan.
How Much Do You Owe?
One major consideration is your loan-to-value ratio. In other words, how much do you owe on the loan compared to your home’s value? You should use today’s value to determine this figure. At the very least, you can get an estimate from Zillow or Redfin to help you determine the estimated value of your home.
Is the LTV less than 80%? If so, you may be in good shape to refinance into a conventional loan. This, of course, depends on your qualifying factors. Do you have a credit score of at least 680? Is your housing ratio around 28% of your gross monthly income? Are your total debts no more than 36% of your gross monthly income? If so, choosing the conventional loan can help you get the most out of your refinance. Waiting until you owe less than 80% of the home’s value is the crucial factor though.
If you owe more than 80% or you don’t have ‘good’ qualifying factors, you may want to either keep your FHA loan or refinance with the FHA Streamline program. This only makes sense if you will save a significant amount of money on the interest, though. If interest rates dropped, it may be time to do just that.
What are Interest Rates Now?
Did you buy your home at a time when interest rates were high? If rates dropped since then, it may be a good time to refinance. You should figure out how much you will save though and how long it will take you to pay off your loan closing costs to refinance.
Let’s say you can save $50 per month by refinancing. If the closing costs run you around $3,000, it would take you 60 months or five years to pay off those closing costs. If you won’t live in the home for more than 5 years, it doesn’t make sense to refinance. If, however, you have no reasonable future plans to move, then refinancing now to get that lower rate may make sense.
Keep in mind, if you refinance with the FHA streamline refinance or take an FHA cash-out refinance, you’ll pay upfront mortgage insurance again. Depending on the type of loan, it can cost you a good amount of money to refinance.
Are you Staying Put?
The largest question to ask yourself is how long you plan to stay in the home. If this is a short-term situation for you, don’t refinance. Just keep what you have since you’ll be paying the loan off in the near future. There’s no reason to pay closing costs just to save a few dollars for the next few years.
If you are staying put, figure out your long-term financial plans. If you are financially fit, refinancing as soon as you owe less than 80% of the home’s value is a great idea. If you don’t have the best credit or you have high debt ratios, you may want to just keep the FHA loan you have. Unless you stand to save a lot of money on your interest rate, paying the closing costs and upfront mortgage insurance again may not pay off in the end.
Refinancing your FHA loan should be a careful decision. Refinancing costs money and it can reset your loan term right back to square one. Make sure you look at the big financial picture and not just what you will gain from the loan right now. This will help you decide when or if there is a right time to refinance.