FHA vs. Conventional Refinance: Which Is Right for You?

When you refinance, you don’t have to stick with the same loan type. 

There may be times when you’d want to refinance your FHA loan into a conventional one or vice versa. (In fact, doing so might even save you money.)

The right decision depends on many factors, though, including how much equity you have in your home, your credit, the budget you’re working with, and more. Use this guide to learn more about FHA and conventional refinances and to determine which one may be right for your goals as a homeowner.

FHA vs. Conventional Refinance: Quick Comparison

FHA loans are mortgages guaranteed by the Federal Housing Administration. Conventional loans aren’t backed by any government agency, though they must adhere to the rules set by Fannie Mae and Freddie Mac. As a result, the refinancing requirements, costs, and other attributes vary widely among these loan options.

Here’s a look at how FHA and conventional refinances vary:

	FHA	Conventional
Refinance options available	Rate-and-term, cash-out, streamline	Rate-and-term, cash-out
Minimum credit score	Typically 580, though it depends on the lender and refinance type	Typically 620, though it depends on the lender and refinance type
Minimum equity required	None for streamline and rate-and-term, at least 15% for cash-out refinances	None, but 20% can help you avoid mortgage insurance
Mortgage insurance required?	Yes, for 11 years or the entire loan term	Only if you have less than 20% equity
Debt-to-income (DTI) limits	43%	45%
Appraisal required?	Not in streamline refinances (FHA to FHA)	Normally, yes, but they can be waived depending on AUS findings

When a Conventional Refinance Is the Better Choice

A conventional refinance is usually the best choice if you know you have at least 20% equity in your home, meaning your current loan balance is 80% or less than your home’s value. For example, if your home is worth $400,000 and you owe $300,000, then you have $100,000 in equity, or 25%.

The 20% equity threshold is important because once you hit that, it means you’ll no longer need to pay for Private Mortgage Insurance (PMI). You could then refinance into a conventional loan and shave a significant amount off your payments just by avoiding mortgage insurance.

Unfortunately, the same option isn’t available with FHA mortgages. On these loans, borrowers are required to cover mortgage insurance premiums (called MIP, in this case) for at least 11 years, no matter how much equity you might have. In some cases, you may even owe MIP for the entire life of the loan. 

If you’re on the cusp of hitting the 20% mark, the decision is a little more nuanced, but choosing a conventional refinance may still be worth it. You’ll pay PMI temporarily until you reach the 20% mark, but once you do, you can ask your lender to cancel the insurance, which will reduce your monthly payment. Calculate the costs and savings of all your refinance options to determine which is the right move for your budget.

Important exceptions: VA loans (mortgages for qualifying veterans and military members) don’t require ongoing mortgage insurance, just an upfront funding fee, and USDA rural home loans have reduced-rate mortgage insurance. If you’re refinancing one of these types of loans, run the numbers carefully to ensure refinancing into another loan type will pay off in the long run. 

The Real Cost of FHA Mortgage Insurance vs. Conventional PMI

FHA loans and conventional loans can both include mortgage insurance costs, so understanding those costs and comparing them is critical to making the right refinancing choice.

With FHA mortgage insurance, you’ll pay both an upfront premium, which costs 1.75% of the total loan amount, and an annual premium, which is divided by 12 and spread across your monthly mortgage payments. For most 30-year loans, annual MIP is 0.55% of the loan balance.

Conventional loans don’t have an upfront mortgage insurance premium, but you will pay an annual one, which ranges from 0.2% to 2% of the loan amount, depending on your credit and loan-to-value ratio. Freddie Mac estimates that PMI adds about $30 to $70 to your monthly payment for every $100,000 you borrow.

Another big difference lies in how long mortgage insurance lasts. FHA mortgage insurance can either last for the entirety of your loan’s term or, if you’re able to make at least a 10% down payment, you can cancel insurance after 11 years. 

Conventional loan mortgage insurance can be canceled when you reach 20% equity, as mentioned above, or if you wait until your loan balance falls to 78% of your home’s value, it will drop off automatically. 

Here’s a look at how both these options compare on a $300,000 loan. 

	FHA	Conventional
Upfront mortgage insurance premium	$5,250	$0
Annual mortgage insurance premium	$1,650	$1,800
Total insurance costs in the first year	$6,900	$1,800
Total insurance costs in 5 years	$15,150	$9,000

When an FHA Streamline Refinance Makes Sense

If mortgage rates have dropped since you bought your home and you currently have an FHA loan, an FHA streamline refinance could save you money with minimal hassle. 

An FHA streamline refinance is when you refinance from one FHA loan to a new one. It allows you to skip much of the typical paperwork, and there is often no credit check, income verification, or appraisal required. The one catch is that you can’t take cash out with these loans (a maximum of just $500 can be added to your balance)

To qualify for an FHA streamline refinance, you must meet the following eligibility requirements:

• Your current FHA loan must be at least 210 days old.
• You must be current on your mortgage payments and have a solid payment history.
• You must gain a net tangible benefit, typically at least a 0.5% reduction in your interest rate.

If your equity is approaching 20%, compare the streamline option against refinancing to a conventional loan. There’s a chance that the insurance savings you’d see from a conventional refinance could outweigh the benefits of an FHA streamline. (If you’re nowhere near the 20% equity mark, though, a streamline refi may be the best way to start saving money immediately.)

FHA vs. Conventional Cash-Out Refinance

Refinancing can also be a tool for taking cash out of your home, and you can do a cash-out refinance with both the FHA loan program and with conventional loans. Again, the requirements and costs can differ, so it’s important to compare the two side by side to determine which is best for your needs.

One important thing to note is that FHA cash-out rates are generally lower than those for conventional cash-out refinances. When you factor in mortgage insurance premiums, though, FHA loans can often end up costlier, despite their lower interest rates. 

Here’s a look at how cash-out refinance options differ between FHA and conventional loans:

	FHA cash-out	Conventional cash-out
Loan-to-value maximum	80%	80%
Mimum credit score	620	620
Occupancy requirement	12 months	None
Mortgage insurance required?	Yes, both upfront and monthly	None if you have 20% equity or more

Again, a conventional cash-out would likely be your best bet if you have 20% equity and could avoid mortgage insurance. 

When You Already Have a Conventional Loan

In most cases, if you already have a conventional loan, you should stick with that when refinancing. The ability to drop PMI at 20% equity makes conventional loans hard to beat, and switching to an FHA loan would lock you into paying mortgage insurance for much longer (or possibly even your entire loan term).

Rare exceptions exist, but they’re uncommon enough that you should run detailed calculations before making the switch from a conventional loan to an FHA one.

When Your Home Value Has Dropped

If your home value has fallen since you took out your loan, it will be hard to refinance your loan at all. This is especially true if you’re in negative equity, also called upside down on your mortgage, meaning you owe more on the house than it’s actually worth. 

If this is your situation, an FHA streamline is the only viable path to refinancing, since it doesn’t require an appraisal. An appraisal would only confirm your home’s lower value and could stop your refinance in its tracks.

When Your Credit Score Has Dropped

A low credit score won’t necessarily disqualify you, but it will make refinancing harder. Most lenders avoid subprime borrowers, those with credit scores below 620, and those who do accept lower credit scores will often charge significantly higher interest rates and closing costs to account for the added risk.

Generally speaking, the higher your credit score, the lower your interest rate will be, so it pays to have good credit before refinancing. On conventional loans, you’ll usually get the best rates at a 740 score or higher. With FHA loans, lower credit scores are allowed and can still come with low interest rates, though mortgage insurance costs should be factored in.

If your credit score is low, an FHA refinance may be your only option. If your score is near 740, though, it might be worth waiting to refinance until you can improve your score and get a low-rate conventional loan. 

Note: If you already have an FHA loan and your credit score is low, an FHA streamline may be your best refinancing option. Most lenders do not conduct credit checks on these types of loans, so your credit won’t factor into your interest rate or loan terms. 

Frequently Asked Questions (FAQs)

The Bottom Line

Choosing the right type of refinance loan is critical if you want to minimize costs, but the answer isn’t always clear-cut. Though every borrower is different, following these general rules can help you make a smart decision for your money:

Choose a conventional loan if:

• Your equity is at or approaching 20%
• You want to eliminate mortgage insurance costs now or in the future
• Your finances and credit are strong

Stick with an FHA loan if:

• Your equity is well below 20%
• You qualify for an FHA streamline refinance
• You need a cash-out refinance with more flexible credit requirements

The smartest approach is to run the numbers on both loan scenarios and get quotes from multiple lenders to ensure you’re seeing the best rates and terms. You can also consult with a mortgage professional or broker for personalized help. They can walk you through real costs for each option and recommend the best solution for your specific situation.