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 mortgage.
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 required.
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 purposes.
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 worthwhile.
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 5.40 percent.
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.