How to Refinance a Government-Backed Mortgage

How to Refinance a Government-Backed Mortgage

If you currently have a government-backed mortgage like an FHA, USDA or VA loan, you can refinance into the same type of loan. You may want to do so if you can qualify for a lower interest rate or you'd like to borrow against your home equity and maintain the benefits of your government-backed mortgage.

Depending on the type of loan you currently have, here are the refinancing programs you may be able to participate in.

FHA Loan Refinance Programs

With an existing Federal Housing Administration (FHA) loan, borrowers have three main ways to refinance into a new FHA loan:

• FHA streamline refinance: Designed to help borrowers quickly refinance their FHA loans, an FHA streamline refinance is possible if you meet certain requirements. You must be able to show that refinancing will result in a "net tangible benefit" to you, depending on the specifics of your loan. You must also be current on your payments and have closed on the loan at least 210 days prior. If you choose the non-credit-qualifying streamline refinance option, you won't need to provide pay stubs or tax forms to verify your income, go through a lengthy credit review or pay for a home appraisal.
• FHA rate-and-term refinance: This option lets you take out a new FHA home loan, of up to 97.75% of your home's value, with a new interest rate and loan term. These loans require income verification, a credit check and a home appraisal, in addition to 12 months of on-time mortgage payments.
• FHA cash-out refinance: With a cash-out refinance, you borrow more than you currently owe on your mortgage and keep the difference in cash. You can borrow up to 80% of your home's value. Requirements include at least 12 months' residence in your home, positive loan payment history for the past 12 months and a credit score of at least 580.

USDA Loan Refinance Programs

Those with a U.S. Department of Agriculture (USDA) loan can refinance into a new USDA loan in one of three ways:

• USDA streamline refinance: This program is similar to other types of streamline refinance options in that it may be faster than a traditional refinance. But you'll still have to meet certain requirements, such as undergoing a credit check and showing that you made on-time payments over the prior six consecutive months.
• USDA streamline assist refinance: To qualify for a USDA streamline assist refinance, you must show that you'll save at least $600 a year by refinancing. You won't need a home appraisal, inspection, credit check or income verification—but you will need to show 12 months of on-time payments toward your original USDA loan.
• USDA rate-and-term refinance: What sets a rate-and-term refinance apart from both of the streamline options is that you will have to get your home appraised. Also, unlike the streamline assist program, a rate-and-term refinance doesn't require that you tangibly benefit from the refinance.

Tip: There's no possibility to choose a cash-out refinance when you're refinancing an existing USDA loan to a new USDA loan.

VA Loan Refinance Programs

Current Department of Veterans Affairs (VA) loan holders can refinance into a new VA loan using one of two programs:

• Interest rate reduction refinance loan (IRRRL): An IRRRL is another type of "streamline" refinance in that it requires less underwriting than traditional refinance options. VA loan borrowers can refinance to lower their rate or convert an adjustable-rate mortgage to a fixed-rate loan. There are no credit check, home equity or appraisal requirements. You will have to pay a VA funding fee, but with an IRRRL it will be lower than the fee you paid for your original VA mortgage.
• Cash-out refinance loan: Like an FHA cash-out refinance, a VA cash-out refinance makes it possible to borrow more than you owe and take the difference in cash. The VA allows you to borrow up to 100% of the appraised value of your home, though lenders may set a different limit. You'll need an appraisal, a credit check and income verification when you apply for the VA cash-out refinance.

Learn more: Pros and Cons of a VA Loan

Refinance to a Conventional Loan

Alternatively, you can refinance a government-backed loan into a conventional loan, the most common type of mortgage. These are backed by private lenders like banks and credit unions and may be harder to qualify for than FHA, USDA or VA loans. But under certain circumstances, and if you can meet the requirements—even if you couldn't when you first applied for a mortgage—a conventional loan could be a good choice.

Here are some reasons you may want to switch from a government-backed loan to a conventional loan:

• Get rid of mortgage insurance. Government-backed loans and conventional loans have different mortgage insurance requirements. For example, mortgage insurance is required on all FHA loans: generally, an upfront fee of 1.75% of the loan amount plus monthly payments that add up to 0.15% to 0.75% of the loan amount per year. This protects the lender from the risk that you'll default. You're required to pay mortgage insurance for the whole FHA loan term if you put less than 10% down initially. But you can refinance into a conventional loan and get rid of these mortgage insurance payments once you have at least 20% equity in your home.
• Pay less interest. You may be able to get a lower interest rate when you refinance, either due to changes in the market or an improvement to your credit score. Conventional loans often require a credit score of at least 620, whereas FHA loans require a credit score of 500 and USDA loans require a credit score of 580. With a higher credit score, you could qualify for a conventional loan when perhaps you couldn't upon initially applying for a mortgage—and you may get a lower interest rate as a result.
• Gain access to a cash-out refinance. Certain government-backed loans, like USDA loans, don't offer a cash-out refinance option. Choosing to refinance to a conventional loan could open up more opportunities for you if, for example, you want to use the proceeds from a cash-out refinance to pay off credit card debt.

Learn more: Average Mortgage Rates by Credit Score

Pros and Cons of Refinancing

No matter the type of loan you choose, refinancing will bring both benefits and drawbacks. Here are the top pros and cons of refinancing.

When You Should Refinance Your Mortgage

Replacing your home loan with a new one could make sense. But you'll spend precious time and money during the process. You may be ready to refinance in the following situations:

• You have enough home equity to qualify. It's common for lenders to require that you have at least 20% equity in your home to qualify for a conventional or FHA cash-out refinance loan. Other loan types have lower equity requirements; an FHA rate-and-term refinance, for example, requires just 2.25% equity. Make sure you meet the lender's minimum prerequisites before proceeding.
• You can get a lower mortgage rate. Compare your current interest rate to prevailing market rates, and get prequalified or preapproved by a few lenders to see the rates you could qualify for. If interest rates have dropped recently or your credit score has improved since taking out your current home loan, then refinancing may mean saving money.
• Refinancing will help you meet a specific goal. Are you looking to reduce your monthly mortgage payments, pay off your loan faster or make use of your home equity? Your objectives will guide your decision and help you choose the right refinance program.
• You'll own the home long enough to justify the costs. Go over the costs associated with refinancing, including closing fees. Calculate your break-even point—the time at which your costs are recouped by savings—to ensure you'll benefit from refinancing.

The Bottom Line

Government-backed mortgages are often strong options for first-time homebuyers or those who couldn't otherwise qualify for a mortgage. But you may find that your needs or financial profile change, making it possible to refinance either to a new government-backed mortgage or a conventional loan. At that point, get clear on your goals and check what interest rates are available to you to choose the refinance approach that is most aligned with your needs. You can check your credit report and FICO^® Score^Θ for free with Experian to see if you could benefit from improving your score before applying for a refinance.