A government-backed loan can often be a hopeful buyer’s big break into homeownership. Mortgages offered by the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), and the U.S. Department of Agriculture (USDA) have made it easier for millions of borrowers to obtain financing by allowing minimal down payments and fair-to-good credit scores.
But, if you chose one of these loans – and have now lived in your home a few years – you may wonder if it’s still the right product for you. Should you explore the possibility of refinancing to a conventional loan?

If you’re considering this idea, let’s explore some of the pros and cons.

Mortgage Insurance Refresh
Before we dive into the benefits and drawbacks, it’s important to understand how mortgage insurance works with each of these loans since this cost can often be a deciding factor.
When putting less than 20 percent down on a conventional loan, your lender will require you to purchase private mortgage insurance, or PMI. Typical PMI rates run about 0.5 to 1 percent of a borrower’s loan balance per year, but it could be a bit higher or lower depending on an individual’s financial situation. Typically, borrowers pay PMI in a monthly premium, and this extra cost falls off automatically once a borrower reaches 22 percent equity, or 78 percent loan-to-value.

On the other hand, some government-backed loans charge a mortgage insurance premium, or MIP. This type of insurance premium is generally used with FHA and USDA loans, and it’s calculated a bit differently than PMI. There is an upfront fee as well as a monthly premium, and the rate is based on the loan amount only.
A big difference between PMI and MIP is how long it’s paid. For instance, for any FHA loans acquired after June 2013, with a loan-to-value greater than 90 percent, MIP remains in effect throughout the life of the loan.

Advantages of Refinancing
So, now that you know the basics of mortgage insurance, let’s look at the benefits of refinancing from a government-backed loan to a conventional option.
Mike Silkworth, senior loan officer with Union Home Mortgage, says for homeowners who’ve built up at least 20 percent equity in their homes, the biggest plus is being able to forget about that pesky mortgage insurance altogether.

“Let’s say you’re paying 4 percent interest and .85 percent mortgage insurance on an FHA loan,” he said. “You may be able to refinance to a conventional loan, and even if it comes with a slightly higher interest rate, you wouldn’t have to carry mortgage insurance. This could mean a lower monthly payment and significant savings over time.”

Disadvantages of Refinancing
To refinance to a conventional loan, you’ll first need to qualify for the mortgage. While many government-backed programs allow less-than-stellar credit scores, some conventional mortgages have stricter credit requirements, and typically the lower the score, the higher the interest rate.

It’s also important to keep in mind that refinancing comes with costs. There are refinancing closing costs to consider.

“The question is are you going to save enough to make it worth the costs?” asks Silkworth. “As a simple example, if refinancing will save you $150 a month and closing costs are $2,000, it will take you 13 months to offset those costs and start realizing the savings.”

Making the Decision
Unfortunately, in the world of mortgages, there is no one-size-fits-all answer. The final decision really comes down to each borrower’s financial situation and long-term goals. That’s why it’s important to have a discussion with a local, professional lender who will analyze the information and help you make a sound decision.

In addition to coaching his clients through the ins and outs of home loans, Silkworth also trains new loan officers at his company, and he continually stresses the importance of strong communication in a successful lender/borrower relationship.

“When discussing a possible refinance, your lender should be asking about your goals,” he said. “Why are you refinancing? Are you looking to shorten your loan term? Lower your monthly payment? How long do you plan on being in the home? If you aren’t being asked these questions, then your lender is not truly looking out for your best financial interests.”

If you’re considering refinancing and would like some expert guidance, visit the Greater Lansing of REALTORS®’ website at www.lansing-realestate.com for a list of trusted local lenders.