What You’ll Learn
What a conventional loan is and how it differs from other types of mortgages
How much home equity you’ll need before you can refinance
What it takes to qualify for a conventional loan refinance
If you purchased your home with a government-backed loan such as an FHA, USDA, or VA loan, now might be the time to refinance to a conventional mortgage loan.
You see, government-backed loans are great for first-time homebuyers because they are easier to qualify for and require low down payments. And in some cases, no down payments at all. But the easy foot in the door that government-backed loans offer comes with monthly mortgage insurance payments and other fees.
If your credit and financial profile have improved or your home’s value has increased, you may be able to refinance to a conventional mortgage—and enjoy significant savings.
Government-backed loans vs. conventional loans
A government-backed mortgage is a type of home loan that’s insured by an agency of the federal government. This means the lender is protected if you can’t repay your mortgage. Examples include FHA, VA, and USDA loans. While they make homeownership available to a wider variety of people, they also come with certain restrictions on the type of property you can buy, what you can use the property for, and they often come with higher interest rates and fees.
A conventional mortgage, on the other hand, is offered by a lender such as a bank, credit union, or mortgage company. Because a government organization does not insure these loans, the lender takes on more risk, which means it’s typically tougher to qualify in terms of down payment and credit requirements.
Benefits of refinancing to a conventional loan from another type of mortgage
There are plenty of reasons to refinance your mortgage. For instance, you may wish to lower your interest rate or your monthly mortgage payment, shorten your mortgage term, change your loan type, or access cash through your home equity.
When it comes to refinancing to a conventional loan from a government-backed loan, you may also be able to tap into significant savings by removing the mandatory fees or mortgage insurance that typically come with government-backed loans.
Here’s a closer look at some of the benefits of refinancing into a conventional loan from a few other popular loan programs.
Refinance an FHA to conventional
According to FHA rules, you may have to wait until you’ve made a minimum of six months’ worth of payments on your original FHA mortgage before you can refinance. Then, you can refinance as soon as you qualify for a conventional loan.
Why you may want to refinance an FHA loan:
- To get rid of mortgage insurance: FHA loans include a mandatory mortgage insurance premium (MIP). If you bought your home with an FHA mortgage and put down less than 10% of the home’s purchase price, then you have to pay MIP for as long as you have the FHA loan. If you made a down payment of 10% or more, you have to pay MIP for 11 years. In contrast, conventional loans require what’s known as private mortgage insurance (PMI) if you buy your home with less than 20% down. A 20% down payment means you had 20% home equity when you bought your home. A great thing about conventional loans is that lenders can remove private mortgage insurance when your home equity reaches 20%. And your home equity increases simply by making your monthly mortgage payments or when property values go up.
- To tap into your home equity: In low-cost areas, FHA loans have lower loan limits than conventional loans. If you’re looking to tap into your home equity with a cash-out refinance, a conventional loan may help you get more of the cash you need.
- To save on interest: If mortgage rates dropped since you took out your FHA mortgage, you might be able to save by lowering your interest rate and your monthly payments by refinancing.
Refinance from VA loans to conventional
VA loans may require you to wait 210 days or have made 6 monthly payments (whichever is longer) before refinancing.
Why you may want to refinance a VA loan:
- To avoid the VA Funding Fee: While you can refinance through a VA refinance program, you’ll have to pay a VA funding fee, which can cost between 0.5% to 3.6% of your loan amount. This cost is in addition to other closing costs that may be required for a VA refinance program.
- To earn rental income: VA loans cannot be used for homes that are solely for investment purposes. If you want to convert your single-family home into a rental property, you’ll need to refinance to a conventional loan first.
- To save on interest: If mortgage rates dropped since you took out your VA mortgage, you might be able to save on interest and your monthly payments by refinancing.
Refinance a USDA loan to conventional
If you obtained a USDA loan with no money down, then you may have to wait until you have at least 3% home equity before you’ll be approved for a conventional refinance.
Why you may want to refinance a USDA loan:
- To avoid the guarantee fee: If you choose to refinance to another USDA loan, you’ll be required to pay an “upfront guarantee fee,” which is equal to 1% of the loan amount. USDA loans also include an annual “guarantee fee.” The annual fee is equal to 0.35% of your loan balance, and the fee is spread out across your monthly mortgage payments.
- To access the equity in your home: The USDA does not currently offer a cash-out refinance option. With a conventional loan cash-out refinance, you can borrow more money than you owe on the home. Then, you can use the extra money to pay for renovations, education costs, or other goals expenses.
- To shorten your loan term: USDA only offers a 30-year fixed-rate loan for home purchases and refinances. If you want to pay off your loan sooner and decrease your overall borrowing costs, then you may benefit from refinancing to a 20-, 15-, or even 10-year conventional loan.
- To save on interest: If mortgage rates dropped since you took out your USDA loan, you might be able to decrease your monthly payments by refinancing.
How to refinance to a conventional loan
When you refinance, you replace your existing mortgage with a new one, so you’ll need to go through the mortgage approval process again. You’ll need to meet the financial requirements of the new loan and will likely have to provide documentation so the lender can verify your finances. .
While exact guidelines may vary slightly by lender, here are the typical conventional loan requirements:
- Credit score: Most lenders require a credit score of at least 620.
- Debt-to-income ratio: Your debt-to-income ratio measures how much of your monthly income goes toward paying debts. Lenders typically look for a ratio less than or equal to 43%.
- Income history: You may be asked to provide W-2s or tax returns for the last two years to prove a stable income.
How much equity do I need to refinance to a conventional loan?
In addition to showing that you have a strong financial profile, you’ll also need enough home equity to be approved for a conventional loan refinance.
Equity is the percentage of ownership you have in your home. To figure out how much home equity you have, subtract your current mortgage balance from your home’s estimated value. Your lender will likely need to confirm the value with a home appraisal. Your lender will then measure your home equity through an equation known as a loan-to-value ratio (LTV).
Here’s an example:
Assessed property value: $300,000
Outstanding loan balance: $210,000
$210,000/$300,000 = 0.70 or 70% LTV
Refinancing to a conventional loan may make the most sense if you have an LTV of 80% or lower. If your LTV is higher than 80%, you may still be eligible for a refinance. However, you’ll likely be required to pay private mortgage insurance (PMI) on top of your monthly mortgage payment. Luckily, unlike other loan types that require mortgage insurance for the life of the loan, you can ask for PMI to be removed after you’ve made enough payments to hit that 80% LTV threshold. (PMI will be removed automatically once you reach 78% LTV.)
Even if your LTV is higher than 80%, you should consider refinancing to a conventional loan if you’re offered a lower interest rate or lower your monthly mortgage payments with a conventional loan.
See how much you can save with a conventional loan refinance
Refinancing to a conventional loan may help you save money on your monthly payments and overall mortgage costs. A cash-out refinance can also help you to access cash for other financial goals or turn your home into an investment property.
If your financial situation has improved since you first got your mortgage, then you may be eligible for a conventional loan. And with Better Mortgage, you can rest assured that you’ll never pay unnecessary fees. In fact, we don’t charge VA funding fees, upfront guarantee fees, lender fees, origination fees, or loan officer commissions on any loans.
Find out if you can save by refinancing to a conventional loan in as little as 3 minutes.