Most people tend to think of FHA mortgages as a tool for
first-time buyers. However, an FHA mortgage can also be used for
refinancing as well, even if the current loan is not an FHA
An FHA refinance offers a number of attractive features,
including low equity and credit requirements, as well as
competitive interest rates. Cash-out refinancing is available for
borrowers with sufficient home equity, and you can even borrow
money for home improvements and repairs against the projected value
of the improved property.
You can also combine a primary and second mortgage into a single
loan, and there's also an FHA refinance option available for
homeowners who are underwater on their current mortgage. And once
you're in an FHA mortgage, future refinancing is simplified through
an FHA Streamline Refinance, which is basically an automatic
refinance with no appraisal, credit check or income verification
On the downside, FHA fees and mortgage insurance tend to run
higher than on a conventional refinance. Also, the amount you can
borrow is lower than on a conventional mortgage, although it varies
depending on local property values.
Cash-out refi, home improvement mortgages available
A standard FHA refinance can be obtained with very little equity
- permitted loan-to-value ratios are as high as 97.75 percent. You
can also obtain a cash-out refinance with an FHA loan, as long as
you still have at least 15 percent equity remaining in the property
after refinancing (85 percent loan-to-value).
If you're looking to do home repairs or other improvements, the
FHA's 203(k) program allows you to borrow up to $35,000 as part of
refinancing. Better yet, it allows you to borrow against the
estimated value of the home once the renovations are completed.
This is a great option for those with limited equity, since it
effectively boosts the value of your home for borrowing
Credit requirements, interest rates favorable
The FHA's credit requirements are fairly loose - officially, you
can obtain an FHA mortgage (including a refinance) with a credit
score as low as 500. However, most FHA-approved lenders won't go
nearly that low - the lenders make the final call on what they'll
accept - so 620 is a more common floor, although you can go lower
if you look around. However, interest rates increase sharply as
credit scores decline, so refinancing with poor credit may not be
Overall, FHA interest rates are quite competitive with those of
conventional mortgages. However, the fees required for FHA mortgage
insurance effectively raises them. FHA new mortgages or refinances
require an upfront fee equal to 1 percent of the loan amount for
mortgage insurance at the time the loan is taken out.
Insurance premiums add to cost
On top of that, you'll also have to pay an annual mortgage
insurance premium that varies according to the length of the loan
and the loan-to-value ratio. On a 30-year fixed-rate mortgage, this
is equal to 1.15 percent of the loan balance per year for mortgages
with less than 5 percent equity, and 1.10 percent for loans with
loan-to-value ratios better than 95 percent. (premiums on 15-year
loans are 0.25-0.50 percent). By comparison, private mortgage
insurance (PMI) on a mortgage with less than 20 percent equity runs
about half a percent a year.
Since these are charged annually (but figured into your monthly
payment), this type of mortgage insurance effectively raises your
annual interest rate. For example, if you have a 30-year FHA
mortgage at 4.25 percent and are paying 1.15 percent a year in
mortgage insurance, you're effectively paying an interest rate of
Refinance program for underwater homeowners
Borrowers who are in negative equity, owing more on a non-FHA
mortgage than their home is worth can apply for an FHA short
refinance. This program provides incentives for lenders to write
off at least 10 percent of the principal on an "underwater"
mortgage so it can be refinanced into an FHA mortgage with a
maximum loan-to-value ratio of 97.75 percent. Any second mortgages
must be resubordinated to the new loan.
To qualify, borrowers must be current on their existing mortgage
but in financial difficulty and at serious risk of default. A high
credit score is not necessary. Getting approved is difficult,
though - lenders have approved only a small number of short refis
under the program and in the end, it's their call to make. However,
it's still worth pursuing if you're in a tight spot.