FHA loans require mortgage insurance for the life of the loan in most cases

Mortgage insurance on an FHA loan cannot be removed the way it can on a conventional loan. Once you take out an FHA loan, you will pay mortgage insurance premiums for as long as you own the home and carry that loan — with one narrow exception.

The only way to stop paying FHA mortgage insurance is to refinance into a conventional loan. This means replacing your FHA loan entirely with a new mortgage that does not require insurance. Whether refinancing makes financial sense depends on your current loan balance, how much equity you have built, interest rates at the time you refinance, and your credit score.

Understanding why FHA loans work this way, and when refinancing actually saves you money, will help you decide whether to stay with your FHA loan or make a move.

Key Takeaways

  • FHA mortgage insurance cannot be removed from your loan no matter how much equity you build or how long you pay.
  • Refinancing to a conventional loan is the only way to eliminate FHA mortgage insurance, but refinancing costs money upfront and requires a new credit check and appraisal.
  • You typically need at least 20 percent equity in your home and a credit score of 620 or higher to refinance into a conventional loan without mortgage insurance.
  • Refinancing makes sense only if the monthly savings on insurance premiums outweigh the closing costs within a reasonable timeframe, usually three to five years.
  • Some FHA loans taken out before June 2013 may have lower insurance costs and may not be worth refinancing away from.

Why FHA loans have permanent mortgage insurance

FHA loans are designed for buyers who cannot put down 20 percent or more. Because the down payment is smaller, the lender takes on more risk. To protect itself, the lender requires mortgage insurance premiums (MIP) — both an upfront premium paid at closing and an annual premium paid monthly.

Unlike conventional loans, where mortgage insurance drops off once you reach 20 percent equity, FHA insurance stays in place for the entire loan term. This is the trade-off for being able to buy with as little as 3.5 percent down. The government backs the FHA loan, but you pay the insurance cost.

If your loan was issued after June 3, 2013, the annual mortgage insurance premium is permanent. Loans issued before that date may have different rules depending on your down payment amount, but most still carry insurance for a long time.

When refinancing to a conventional loan makes sense

Refinancing works only if you have built enough equity and your financial situation has improved since you took out the FHA loan. Most conventional lenders will not insure a loan for more than 80 percent of your home's current value — meaning you need at least 20 percent equity to avoid mortgage insurance on the new loan.

You will also need a credit score of at least 620, though most lenders prefer 640 or higher to offer competitive rates. If your credit has improved since you got the FHA loan, refinancing may get you a better interest rate on top of eliminating the insurance.

The real question is whether the monthly savings justify the cost. Refinancing involves closing costs — typically 2 to 5 percent of the loan amount — plus an appraisal, title search, and credit check. If you are refinancing a $200,000 loan, closing costs could run $4,000 to $10,000. You need to calculate how many months of insurance savings it will take to break even.

How to calculate whether refinancing saves you money

Start by finding out your current FHA mortgage insurance premium. This appears on your loan statement as an annual percentage of your loan balance. For loans issued after June 2013, the annual MIP is typically between 0.55 and 0.80 percent depending on your down payment and loan amount.

Multiply your current loan balance by that percentage to find your annual insurance cost. Divide by 12 to get the monthly amount. For example, if you owe $180,000 and pay 0.80 percent annual MIP, that is $1,440 per year, or $120 per month.

Next, get a refinance quote from a conventional lender. Ask for the estimated closing costs and the new interest rate. Calculate the monthly payment on the new loan and subtract your current FHA payment. The difference is your monthly savings. Divide your closing costs by the monthly savings to find your break-even point in months. If you plan to stay in the home longer than that, refinancing likely makes sense.

Example: If refinancing costs $6,000 and saves you $120 per month on insurance, you break even in 50 months (about 4 years). If you plan to stay 10 more years, refinancing pays for itself twice over.

The refinancing process and timeline

Refinancing an FHA loan into a conventional loan follows the same basic steps as getting a new mortgage. You will need to submit financial documents, undergo a credit check, and have the home appraised. The lender will verify your income and employment, just as they did for your original loan.

The appraisal is critical because it determines your home's current value and therefore how much equity you have. If the appraisal comes in lower than you expected, you may not have 20 percent equity and will still need mortgage insurance on the new loan.

The entire process typically takes 30 to 45 days from application to closing. During this time, you continue paying your FHA loan as normal. Once the new loan closes, the old FHA loan is paid off and you begin making payments on the conventional loan.

Alternatives if refinancing does not make sense

If you do not have enough equity, your credit score is too low, or interest rates are higher than your current FHA rate, refinancing may not be worth it. In that case, you will continue paying FHA mortgage insurance for as long as you keep the loan.

One option is to wait. As you pay down the loan balance and your home appreciates, your equity grows. In a few years, refinancing may become more attractive. You can also focus on improving your credit score if it is holding you back — a higher score will may have access to you for better rates and may make refinancing worthwhile sooner.

Another path is to make extra principal payments on your FHA loan if you can afford it. This builds equity faster and gets you closer to the 20 percent threshold. Even though it does not eliminate the insurance, it shortens the time until refinancing becomes an option.

What happens to your FHA loan if you refinance

When you refinance, your old FHA loan is paid off in full on the day the new loan closes. You will no longer have any obligation to that loan. The new conventional loan is a separate mortgage with its own terms, interest rate, and payment schedule.

If you refinance into a 15-year loan instead of staying with a 30-year term, your monthly payment will be higher but you will pay off the home faster and pay less interest overall. If you refinance into a new 30-year loan, your payment may be lower even without the insurance savings, depending on interest rates.

Keep in mind that refinancing resets your loan term. If you are 10 years into a 30-year FHA loan and refinance into a new 30-year conventional loan, you are back to a 30-year payoff schedule. If you want to stay on track to pay off the home at the same time, you would need to refinance into a 20-year loan instead.

Frequently Asked Questions

Can I remove FHA mortgage insurance by paying off my loan early?

No. FHA mortgage insurance stays in place as long as you carry the FHA loan, regardless of how much you have paid down. The only way to eliminate it is to refinance into a conventional loan or pay off the entire loan balance at once.

What if my home value has dropped since I bought it?

If your home is worth less than you owe, you have negative equity and cannot refinance into a conventional loan without mortgage insurance. You would need to wait for your home to appreciate or pay down the loan balance until you have at least 20 percent equity.

Do I have to refinance the entire loan amount?

Yes. Refinancing replaces your entire FHA loan with a new conventional loan. You cannot refinance just part of it. However, you can refinance for less than you currently owe if you want to pay down the principal at the same time, though this requires cash at closing.

Will refinancing hurt my credit score?

Refinancing will cause a small, temporary dip in your credit score due to the hard inquiry and new account. The impact is usually 5 to 10 points and recovers within a few months. The long-term benefit of a lower interest rate typically outweighs this short-term effect.

What if interest rates are higher now than when I got my FHA loan?

If rates have risen significantly, refinancing may not make sense even if you have enough equity. You would be trading FHA mortgage insurance for a higher interest rate, which could cost you more overall. Compare the total cost of keeping your FHA loan against the total cost of refinancing before deciding.