A cash-out refinance loan could help you access the equity in your home to cover the cost of home renovations, college tuition, or another big expense. Equity is the amount the property is worth, minus any money owed to the bank on a mortgage loan.
An FHA cash-out refinance is one approach to accessing home equity, and this guide will help you decide if it's the right one for you.
What is an FHA cash-out refinance?
The Federal Housing Administration (FHA) is part of the Department of Housing and Urban Development (HUD), a federal agency created to offer housing support. The FHA guarantees mortgage loans, which means the government provides insurance for lenders in case borrowers don't pay back the loan amount due. One loan type the FHA guarantees is an FHA cash-out refinance loan, allowing eligible borrowers to tap into their home equity.
If approved for an FHA cash-out refinance, you take a new mortgage out with the FHA, which repays your entire existing mortgage and gives you cash back. For example, if you owed $150,000 on a home with an appraised value of $300,000, you might take a $200,000 cash-out refinance loan. With the loan proceeds, you'd repay your existing $150,000 mortgage and do whatever you want with the other $50,000.
You could use the remaining loan proceeds for home improvements, to repay high-interest credit card debt, or for any other purpose. Of course, you are borrowing against the equity in your house. That means you are putting your home at risk of foreclosure in cases of nonpayment, so be smart about how much equity you access by borrowing.
An FHA cash-out refinance loan is just one way to access the equity in your home. Understanding the difference between cash-out refinances vs. home equity loans and HELOCs vs. home equity loans can help you choose the best borrowing option for you.
FHA cash-out refinance guidelines
There are certain requirements that borrowers must meet in order to be eligible for a cash-out refinance loan. While the FHA sets minimum requirements for loans it guarantees, it's important to note that individual lenders might impose stricter rules when qualifying borrowers if they choose to do so.
FHA cash-out refinances are also subject to FHA loan limits. For 2021, those limits are $356,362 for low-cost areas and $822,375 for high-cost areas.
Minimum credit score
As a general rule, borrowers securing FHA loans must have a minimum credit score of 500. However, some mortgage lenders may impose a higher minimum credit score for cash-out refinance loans. Some set their credit score requirement as high as 580 or 600.
Maximum loan-to-value ratio
Lenders do not allow you to borrow 100% of the value of your home. Instead, they set a maximum loan-to-value (LTV) ratio. That's the ratio of the amount you're eligible to borrow relative to the appraised value of the property guaranteeing the loan.
The FHA used to offer a 95% cash-out refinance loan option. With this loan, you were allowed to borrow up to 95% of the value of your home. To qualify, you needed to have lived in and made payments on your home for at least 12 months.
However, in 2019, the FHA changed the rules. You can now borrow only up to 80% of what your home is worth using an FHA cash-out refinance loan. For eligible borrowers, this means if your home is valued at $300,000, your total cash-out refinance mortgage loan amount would be $240,000.
Maximum debt-to-income ratio
The amount of money you can borrow depends on how much you earn and how much debt you have. Lenders compare your monthly debt payments to your monthly gross income. This is called your debt-to-income (DTI) ratio.
The FHA's DTI ratio requirements apply to both mortgage debt and total debt. Borrowers must keep their mortgage debt costs below 31% of gross monthly income. And total payments on all recurring debts, including their mortgage and other debts — such as car loans and credit cards — must be below 50%.
Again, some lenders may voluntarily set stricter standards, such as capping total payments, including mortgage debt, at 43% of income or below.
Only owner-occupied homes are eligible for a cash-out refinance loan. Homeowners must have owned and lived in the house as their primary residence for 12 months prior to borrowing.
However, there are limited exceptions to this rule. For example, suppose a borrower inherited a property and didn't rent it out at any time. In that case, they don't have to fulfill the 12-month occupancy rule to be eligible for an FHA cash-out refinance loan.
Payment history requirements
Borrowers must have made all payments within the month of the due date for the 12 months prior to applying for the cash-out refinance loan. So for instance, if you’ve been in your home for just over a year, you would need at least 12 on-time mortgage payments to meet the payment history requirement.
Mortgage insurance requirements
The FHA requires borrowers to pay mortgage insurance premiums (MIPs), both upfront and on a monthly basis. The upfront mortgage insurance cost is 1.75% of the loan amount, which is due at closing. Monthly payments can vary depending on the loan amount and loan-to-value ratio, but total premiums can add up to 0.45%-1.05% of the loan amount each year.
FHA mortgage insurance can increase the cost of your mortgage payments. Conventional lenders typically don't impose these added costs as long as you borrow less than 80% of what your home is worth.
Conventional vs. FHA cash-out refinance: A quick comparison
In addition to FHA cash-out refinances, many lenders also offer conventional cash-out refinances. It's important to understand the difference between FHA vs. conventional loans when deciding which option is better for you.
Conventional loans don't have government backing and could be harder to qualify for. However, the specific eligibility rules can vary from lender to lender for both conventional and FHA loans.
|Conventional cash-out refinance||FHA cash-out refinance|
|Minimum credit score||600 to 640||500|
|Maximum LTV ratio||80% to 90%||80%|
|Maximum DTI ratio||50%||50%|
|Mortgage insurance required||Sometimes, varies based on loan-to-value ratio||Yes, up-front and monthly premiums|
Who is an FHA cash-out refinance right for?
An FHA cash-out refinance loan could be a good option if you have a lower credit score. However, you need to make sure you've made 12 on-time payments and lived in your home for 12 months before applying for an FHA cash-out refinance loan.
You also need to be comfortable paying both upfront and ongoing mortgage insurance premiums with an FHA cash-out refinance loan. These payments generally won't be required with a conventional lender, unless you borrow more than 80% of your home’s value. And with conventional loans, private mortgage insurance premiums are paid monthly. There’s no upfront fee.
How to apply for an FHA cash-out refinance
If you’re wondering how to get a loan, you'll need to find a private lender that offers FHA cash-out refinances and work with a loan officer to complete their application process. You will also need to decide how much you want to borrow and make sure your home will appraise for enough to allow you to access the desired loan amount.
The application process will likely be similar to other types of mortgage refinancing. Your lender will check your credit report, and you’ll be required to provide personal information and financial documentation. Your loan will then go through the underwriting process. If approved, you'll sign your new loan documents and pay off your current loan.
Many of the best mortgage lenders offer FHA-guaranteed refinance loans, which may allow you to tap into the equity in your home.
What’s the maximum LTV for an FHA cash-out refinance?
The maximum loan-to-value on an FHA cash-out refinance loan is 80%. While borrowers used to be able to borrow up to 95% of their home's value, this is no longer the case.
Does an FHA cash-out refinance require an appraisal?
An FHA cash-out refinance loan requires an appraisal to determine the value of your home. You will be responsible for paying for an approved appraisal. Generally, your lender will arrange the appraisal.
Do you need to pay closing costs with an FHA cash-out refinance?
Closing costs must be paid with an FHA cash-out refinance loan. The closing costs vary depending on many factors, including the lender you choose and the amount borrowed. In general, closing costs for FHA loans range between 2%-6% of the total loan amount.
What’s the difference between an FHA cash-out refinance and an FHA streamline refinance?
There are two primary types of FHA refinance programs: the cash-out refinance and the streamline refinance.
You do not need an existing loan with the FHA to qualify for an FHA cash-out refinance. This type of refinancing allows a borrower to tap into their home’s equity to cover other costs.
With an FHA streamline refinance, there’s no cash-out component. Borrowers with a current FHA mortgage simply replace their loan with a new loan. Streamline refinances are often used to access a lower interest rate or replace an adjustable-rate loan with a fixed-rate one.
An FHA cash-out refinance loan could be a good option if you want to change your current mortgage terms and access the equity in your home at the same time. Just make sure to research your loan options because there can be differences in mortgage rates and qualifying requirements among lenders offering FHA refinance loans.
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