Conventional Versus FHA Refinancing

Refinance loan options can be split into two categories: conventional mortgage loans and government-insured, most commonly those insured by the Federal Housing Administration (FHA). 

While both conventional and FHA loans each have their advantages, borrowers should understand the pros and cons of each to choose the optimal loan.

Determining Refinancing Objectives

Before performing a refinance, borrowers should determine what objectives they would like to accomplish through the transaction. 

Borrowers tend to refinance to change the payment plan of their mortgage, to shorten the length of the loan term, or to lower their current interest rates and monthly payments.

For instance, a borrower with an adjustable-rate mortgage may refinance into a 30-year fixed-rate mortgage for more stable mortgage payments and a safer, long term investment. 

Borrowers may additionally opt for a 15-year mortgage in the interest of reducing the loan term and consequently reducing the overall interest payments over the loan lifetime. 

However, the majority of borrowers refinance to acquire better interest rates, whether due to more favorable rates being readily available or after repairing their credit score and qualifying for better rates. Whatever the goal, borrowers should always determine their aims in refinancing and how best to satisfy these aims. 

This step is especially important when deciding between a conventional and FHA refinance, as each option provides unique advantages that may satisfy some refinance objectives while neglecting others.

Comparing Conventional and FHA Refinance Loans

Regardless of your goals, refinancing can be an attractive reinvestment in your home; however, choosing between an FHA refinance and a conventional refinance will take some deliberation. Consider these pros and cons of conventional and FHA refinancing:

Conventional Refinancing Pros

• More flexible mortgage insurance
• Higher loan limits

Borrowers who own less than 20% of the equity on their homes should consider getting a conventional refinance to avoid FHA private mortgage insurance. 

Unlike FHA loans which require a minimum of 5 years paying mortgage insurance premiums, conventional mortgage insurance can be eliminated in as little as two years with consistently on-time payments and an LTV of 78% or below.

Additionally, conventional refinancing can potentially provide borrowers with more funds than FHA refinancing, as super-conforming and non-conforming loans have much higher loan limits.

Conventional Refinancing Cons

• Stricter guidelines
• Higher mortgage rates on non-conforming loans
• May include prepayment penalties, additional charges

Conventional mortgage loans carry strict guidelines on borrower credit scores, and homeowners with poor credit will not be able to secure beneficial rates with a conventional mortgage.

Also, non-conforming conventional loans involve more risk than conforming loans, as they are much more difficult to sell on the secondary market. As a result, non-conforming loans carry much higher interest rates and would be disadvantageous to borrowers who do not need a large amount of funding.

Moreover, since conventional loan regulations differ from state to state as well as lender to lender, these mortgage loans may contain unfavorable conditions such as prepayment penalties, alienation terms, or acceleration clauses.

FHA Refinancing Pros

• Lenient credit requirements
• Streamline option available
• No prepayment penalties

Due to being regulated and insured by the Federal Housing Administration, FHA loans have remarkably lenient credit requirements, and even borrowers with poor credit can secure excellent rates under the right circumstances.

For borrowers with a pre-existing FHA mortgage, the Federal Housing Administration offers the option of performing an FHA streamline refinance. 

FHA streamline refinances allow to borrowers to revise the terms of their mortgages while circumventing the typically-required home appraisal and sometimes even without income verification. 

Consequently, borrowers with homes that have decreased in value can benefit tremendously from this refinance, as they may secure lower rates without negatively affecting their LTV ratio.

Furthermore, FHA refinances do not carry prepayment penalties and thus have some additional flexibility with repayment.

FHA Refinancing Cons

• Rigid mortgage insurance policy
• Lower maximum loan limits

Regarding mortgage insurance, FHA refinances have more rigid requirements than conventional loans. At a minimum, FHA refinance borrowers must pay private mortgage insurance premiums for five years, although some borrowers may be eligible for a private mortgage insurance refund.

Also, FHA loans do not offer as much funding as conventional loans, which include non-conforming jumbo loans.

You should perform a conventional refinance if…

• You own less than 22% of your home’s equity and would like to avoid private mortgage insurance.
• FHA private mortgage insurance is more expensive than potentially higher interest rates with a conventional mortgage.
• You require more funding than is available with an FHA loan.

You should perform an FHA refinance if…

• You have low or damaged credit or an inconsistent credit history
• You are eligible for an FHA streamline to refinance, and the value of your home has decreased since originally purchased.

Gretchen Wegrich

Gretchen Wegrich is an editor at Lender411. She specializes in mortgage basics, personal finance and green living. She graduated with a bachelor's degree in writing from University of California, San Diego and previously worked at the Santa Cruz Sentinel. Contact her at gretchen@lender411com.