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Want to refinance your FHA loan? Here are 4 options.

Yahoo Personal Finance· Getty Images
Updated 6 min read

While many people assume that the only reason to refinance a mortgage is when interest rates drop, you can actually accomplish multiple financial obectives by refinancing.

Homeowners with FHA loans may qualify for several Federal Housing Administration programs. Each of these FHA refinance loans has its own advantages and can help you achieve specific goals.

Dig deeper: Is now a good time to refinance your mortgage?

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Whether you’re hoping to lower your monthly payments with the help of a better mortgage rate or a new loan term or shorten your loan term to pay off your home faster, an FHA refinance loan may be the tool for reaching your goal.

Many homeowners choose to refinance to pay for home improvements. If you want to pay for a renovation by refinancing, you can consider an FHA cash-out refinance or an FHA renovation loan.

Other reasons to refinance an FHA loan are to switch from an adjustable-rate mortgage (ARM) to a fixed-rate loan or to remove a co-borrower from your mortgage loan. You may also consider an FHA cash-out refinance to pay off other high-interest debt.

Read more: How soon can you refinance your mortgage after buying a home?

When you refinance a mortgage, you are swapping one loan for another. That means you must qualify for the new loan according to the lender’s requirements.

FHA loans require a minimum credit score of 580, but some lenders have a higher minimum credit score requirement. In addition, your debt-to-income ratio (DTI), which compares the minimum monthly payment on all recurring debt to your gross monthly income, should be 43% or less. However, some FHA loan refinance options may be more lenient.

In addition, depending on the FHA refinance program you choose, you’ll need to pay closing costs, typically 2% to 6% of the loan amount. FHA loans require mortgage insurance, which will be part of your monthly payment.

Read more: The best FHA loan lenders

An FHA Streamline Refinance is available to current FHA borrowers who want to refinance into another FHA home loan. Homeowners must have made at least six months of on-time payments, cannot be delinquent on their mortgage, and be able to demonstrate a tangible benefit to refinancing, such as a lower monthly payment.

Your payment may be lower if you lock in a lower interest rate or if you have paid down your loan and the balance is significantly reduced from the initial mortgage.

The FHA Streamline Refinance option means you don’t need an appraisal, and you may not need to undergo a credit check or income verification. However, you must pay FHA loan closing costs up-front rather than wrap them into the loan balance. Closing costs are typically 2% to 6% of the loan amount.

Dig deeper: 9 ways to refinance your mortgage with a bad credit score

As with an FHA Streamline Refinance, an FHA Simple Refinance is available to FHA borrowers who want to refinance into another FHA mortgage. You must have made at least six on-time monthly mortgage payments and meet minimum FHA credit score requirements.

The FHA Simple Refinance does require a home appraisal to assess your property value. Unlike the FHA Streamline Refinance program, you can wrap your closing costs into the new loan balance as long as the loan doesn’t exceed 97.75% of the home's value.

Learn more: How your loan-to-value ratio (LTV) impacts your mortgage

If your home has increased in value since you bought it, you have paid down the loan balance, or both, you may be eligible for an FHA cash-out refinance. Unlike the Simple or Streamline Refinance, you can take cash from your home equity. However, your loan cannot exceed 80% of your home value.

For example, if your home is appraised at $400,000, you can borrow up to $320,000. If your current loan balance is $240,000, you’d still have $80,000 left over in cash after using the loan to pay off your $240,000 principal ($240,000 + $80,000 = $320,000). If you want to wrap your closing costs into the loan, you’ll take out less cash.

To qualify for an FHA cash-out refinance, you must live in the property as your primary residence, have made 12 on-time payments on your current loan, meet a minimum credit score requirement set by the lender, and meet debt-to-income ratio standards (typically a maximum of 43%).

Read more: How does a cash-out refinance work?

If your goal is to renovate your home, you may want to consider refinancing your FHA loan or conventional loan into an FHA 203(k) loan, which wraps home improvement expenses into your new loan balance. Depending on how much work needs to be done and whether the work is structural or not, you can apply for a limited or standard FHA 203(k) refinance.

Specific rules govern the types of projects that can be financed with an FHA 203(k) refinance. The standard FHA 203(k) loan requires an FHA consultant to help manage it. Both types of rehabilitation loans require minimum credit scores set by the lender and an appraisal of the home's current market value and the estimated value after the improvements are completed.

Learn more: The pros and cons of FHA loans

Refinancing an FHA loan requires closing costs that range from 2% to 6% of the loan amount. Depending on the FHA refinance program, you may be able to wrap those closing costs into your new loan balance.

FHA loans require mortgage insurance, including an up-front mortgage insurance payment of 1.75% of the loan amount at closing and ongoing mortgage insurance premium (MIP) payments. If you have had your original FHA home loan for three years or less, you may qualify for a partial refund on the up-front mortgage insurance on your new refinanced mortgage.

Dig deeper: How to remove FHA mortgage insurance

The time you must wait before refinancing an FHA loan depends on the type of refinancing program you choose. You need to wait six months with an FHA Streamline or Simple Refinance. An FHA cash-out refinance requires you to live in the home for 12 months.

Yes. When you refinance into an FHA loan, you may only borrow up to the FHA loan limits set annually for each county. You can look up county limits at the HUD site.

Yes, you can refinance out of an FHA loan and into a conventional loan if you qualify for a conventional mortgage. You’ll likely need a higher credit score for a conventional loan. You may prefer a conventional loan if you have 20% or more in equity in your home because then you won’t have to pay for mortgage insurance.

While FHA’s minimum credit score is 580, a mortgage lender may set their own higher credit score requirement.

This article was edited by Laura Grace Tarpley