Do you currently have a USDA loan? The U.S. Department of Agriculture backs loan programs designed to help low- to moderate-income individuals and families buy homes in eligible rural areas.
However, a USDA loan might not be the long-term financing option you are looking for, especially if you plan on converting your home into a rental property. In this article, we’ll cover a few reasons why refinancing a USDA loan into a conventional loan might be beneficial and what the refinancing process entails.
Why Refinance from a USDA Loan to a Conventional Loan?
While the USDA loan program offers valuable benefits, such as low interest rates and flexible credit requirements, it also comes with certain limitations. If your financial goals or housing plans have changed, there are several reasons you may want to refinance into a conventional loan.
Cash Out Home Equity
USDA loans do not allow cash-out refinancing, which means you can’t tap into your home’s equity through a traditional refinance. To access your equity—whether for home improvements, debt consolidation, or other financial goals—you’ll need to refinance into a conventional, FHA, or VA loan.
USDA loans also prohibit secondary financing like Home Equity Lines of Credit (HELOCs), further limiting your options until you switch loan types.
If you’re eligible for other government-backed options, you can explore alternatives like an FHA cash-out refinance or a VA cash-out refinance to access your equity.
Owner-Occupancy Changes
USDA loans are intended for owner-occupied homes, meaning you must live in the property as your primary residence when the loan is originated—and for a reasonable period after. If you plan to convert your home into a rental property, you may still keep your USDA loan, but refinancing within the USDA program likely won’t be an option.
To remove occupancy restrictions, you’ll need to refinance into a conventional loan. USDA loans also can’t be used for second homes or vacation properties, and buying a new primary residence while keeping your USDA loan could violate program guidelines.
Remove USDA Guarantee Fees
Another reason to refinance your USDA loan into a conventional loan is to eliminate the ongoing guarantee fees that USDA loans require. While USDA loans don’t have Private Mortgage Insurance (PMI), they charge similar costs in the form of an upfront guarantee fee and an annual fee added to your monthly payments.
If you refinance into a conventional loan and have at least 20% equity, you can avoid both USDA fees and conventional PMI, potentially reducing your overall borrowing costs.
Shorten Your Loan Term
USDA loans only offer a 30-year repayment period. If you’d like to shorten your loan term to 10, 15, or even 20 years, refinancing into a conventional loan is your best option.
USDA Refinancing
The USDA does offer loan refinancing. However, the same restrictions apply to newly refinanced loans, which is why many borrowers pursue a conventional loan. There are three main USDA refinancing options.
- USDA Streamlined-Assist Refinance—This process is best if you want to lower your interest rate and loan payment. It is available if you have minimal equity in your home.
- USDA Streamlined Refinance—This program is similar to the USDA Streamlined-Assist Refinance program. It won’t require a new appraisal, but the lender will do a credit and income check. Learn more about both USDA streamlined refinance options here.
- USDA Non-Streamlined Refinance—This loan program is similar to taking out a new mortgage with a new appraisal, full income review, and credit check.
These refinance options should only be used if you want to lower your monthly payment and remain within the USDA loan program.
The Refinancing Process
If you decide that refinancing is the right option for your USDA loan, you must go through a process similar to taking out a new loan. Remember, the refinance process will look different for each borrower, so consult with a qualified lender to learn more.
Nevertheless, here are the steps you can expect:
Step 1: Check If You’re Eligible to Refinance
Before starting the refinance process, you must ensure your loan is eligible. For some USDA refinance options, such as the Streamlined-Assist Refinance, you must wait at least 12 months after the loan is originated.
Step 2: Find a Lender
Not all lenders offer conventional refinancing for USDA loans, so it’s important to choose a lender experienced with both USDA and conventional loan guidelines.
Each loan type comes with its own requirements, such as holding periods or occupancy rules. Work with a lender who understands both USDA and conventional loan guidelines to ensure a smooth transition.
Step 3: Negotiate Terms
Part of the refinancing process will involve a home appraisal and determining your borrowing eligibility. Even though your home may appraise at $400,000, you might only be able to borrow $350,000.
This is where negotiation comes into play. Lenders do have some leeway to work with you based on your situation.
Consider negotiating your repayment term, interest rate, appraisal amount, closing costs, and monthly payment.
Step 4: Close
Once you’ve negotiated your terms and agreed with your lender, you will close on your new loan. Remember, a refinance process eliminates the old loan, meaning you will have no further ties to your USDA loan.
This may give you more flexibility, such as opening a HELOC, removing mortgage insurance if you have sufficient equity, or converting your home into a rental, subject to the new loan’s terms and lender approval.
The Bottom Line
Refinancing from a USDA loan to a conventional loan might make sense if you want to pull equity out of your home, remove mortgage insurance, or convert your primary residence into a rental property.
The refinancing process looks different for each borrower. Don’t be afraid to shop around to find the right lender and negotiate on your terms.
Ready to get started? Start your refinance application with Refi.com today.
