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How to choose the right FHA refinance term

FHA refinancing can be a good option for borrowers with credit challenges or those who have a higher-than-average debt-to-income ratio; but if you're interested in an FHA refinance, be sure to consider the impact of a different loan term on your finances. FHA lenders typically offer both a 15-year-fixed-rate home loan and a 30-year-fixed-rate home loan, so you should consider the pros and cons of each option in the context of your financial plan.

FHA home refinance: shorter or longer?

For some homeowners, the decision about a new loan term is simple: If you are tight on funds and your goal is to ease your cash flow, refinancing your home into a new 30-year-fixed-rate loan is your best bet. In fact, you may only be able to qualify for a 30-year home loan because of the FHA requirements that your overall debt-to-income ratio must be at or below 43 percent.

If you have more room in your budget, you can decide whether a 30-year loan with lower payments is a better option than a 15-year loan with a lower interest rate and a quicker payoff date.

For example, a 30-year-fixed-rate loan for $200,000 at 4.5 percent will have a principal and interest payment of $1,013. A $200,000 15-year-fixed-rate loan at 3.7 percent will have a principal and interest payment of $1,449. However, you will pay off your loan 15 years faster and save $103,905 in interest payments with the shorter loan term.

While paying off your mortgage faster and eliminating some of your interest payments are good goals, you should be certain that you are contributing enough to your retirement plan, have a robust emergency savings plan and have paid off high-interest-credit-card debt before you choose to devote more cash to your mortgage payoff.

Mortgage insurance and FHA refinancing

In addition to calculating your mortgage principal and interest based on various loan terms, you'll need to estimate your mortgage insurance premiums. The FHA changed the rules on mortgage insurance as of June 3, 2013, and will now require many borrowers to pay mortgage insurance for their entire loan term regardless of the loan-to-value. Borrowers with a loan-to-value of less than or equal to 90 percent at the start of their new loan will be required to pay mortgage insurance for 11 years. If you have a loan-to-value greater than 90 percent, you will have to pay mortgage insurance for the entire loan term. FHA rules base the loan-to-value on the appraised value of your home at the time of your refinance without the inclusion of upfront mortgage insurance, which many borrowers add to their balance.

If you have an FHA loan now, you may qualify for a streamline refinance, in which case the rules about your mortgage insurance will vary according to when you took out your first FHA loan. Consult with an FHA lender for an individualized evaluation of your FHA refinance options.

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