An FHA cash-out refinance can help you tap the home equity you’ve built up over the years if you have specific financial goals in mind. Since the lender holds your real estate as collateral, interest rates for refinancing loans tend to be much lower than rates for unsecured debt like personal loans or credit cards. Another benefit, especially for borrowers with less-than-perfect credit, is that FHA mortgages, which are insured by the Federal Housing Administration, are typically easier to qualify for than conventional mortgages.
The best part: You can use this program whether you already have an FHA mortgage, a conventional mortgage, or no mortgage at all. Unlike some types of FHA refinance programs, an FHA cash-out refi doesn’t require that you currently have an FHA mortgage.
What is an FHA cash-out refinance?
With a regular cash-out refinance, you can access some of your home equity by taking out a new, larger mortgage on your house. Some of the new home loan goes to pay off the old mortgage, while the remaining money — less any closing fees — is paid to you as a lump sum payment. You can use the cash to pay for whatever you want.
An FHA cash-out refinance works the same way, but you get the added benefit of less-stringent credit requirements than regular mortgages.
If your home is totally paid off, you can still use an FHA cash-out refinance to withdraw some of your home equity and get an FHA loan.
How much can you cash out with an FHA loan?
The FHA cash-out refi program has a maximum allowed loan-to-value (LTV) ratio of 80% of the appraised value of your home, meaning you must maintain at least 20% equity in the home. The amount you’d pocket from the transaction depends on how much you still owe on your current mortgage.
Example: On a $250,000 home, you are required to keep at least $50,000 (20% of $250,000) in home equity after the cash-out refinance. Since you can borrow up to 80% of the home’s value, the biggest FHA loan you could potentially get would be $200,000.
Now assume you still owe $150,000 on your existing mortgage. After using the new mortgage to pay off that balance, $50,000 remains. Once you subtract closing costs, say $3,000, the remaining $47,000 would be available to you as a lump sum.
Note the 80% allowable LTV ratio might not apply if your home is expensive and your loan exceeds the FHA limit. Each year, the FHA sets dollar limits for mortgages it will insure. In 2022, the limit is generally $420,680, although designated high-cost areas have special limits as high as $970,800.
FHA cash-out refinance requirements
To be eligible for an FHA cash-out refi, you must meet these requirements:
|Minimum credit score||580 (some lenders may set lower/higher minimums)|
|Loan-to-value ratio (LTV)||80% of the appraised value of the home|
|Debt-to-income ratio (DTI)||31% front-end DTI
43% back-end DTI
|On-time mortgage payments||12 months or as long as you’ve owned the property, whichever is less|
|Mortgage history||Minimum of six months of mortgage payments|
In addition, FHA mortgage guidelines require:
- The property must be your principal residence.
- Any co-borrowers must also be occupants.
- The home can’t be rented out as an investment property.
- You must have made on-time mortgage payments for 12 months, or as long as you’ve owned the property, with a minimum of six months.
While the FHA loan program requires a minimum credit score of 500, many FHA-approved mortgage lenders (including Finance of America Mortgage) set higher minimum credit score requirements. On debt-to-income ratios, FHA guidelines specify that the estimated mortgage payment generally shouldn’t exceed 31% of your income (known as “front-end DTI”), and all your monthly bill payments shouldn’t exceed 43% (“back-end DTI”). If your DTI ratios exceed these limits, the lender may still approve the refinance if you can provide acceptable explanations.
You must show at least six months of mortgage payments to receive FHA cash-out refinancing if you currently have a mortgage. And if you own your home free and clear, you can still use an FHA cash-out refi. However, you can’t get an FHA loan if you’re delinquent on any federal taxes.
Pros and cons of an FHA cash-out refinance
Here’s a look at the FHA cash-out refinance program pros and cons.
|● Easy credit terms
● Lower interest rates
● No existing FHA loan requirement
● Path to access your home equity
● Can use the funds for any reason
|● Must pay FHA mortgage insurance
● Must pay for an FHA appraisal
● Subject to FHA loan limits
● Reduces your home equity
● Requires closing costs
FHA cash-out refinance alternatives
Besides FHA cash-out refinances, several options exist for tapping your home equity:
- Conventional cash-out refinance: Conventional refis generally have higher credit score requirements, stricter underwriting standards, and higher interest rates than FHA cash-out refinances. On the plus side, no private mortgage insurance is required as long as you maintain 20% home equity.
- HELOC: A home equity line of credit works a bit like a credit card in that you are approved for a revolving credit line up to a certain amount. You spend the amount you choose whenever you need it and pay interest only on that amount. This can save you quite a bit in borrowing costs if you don’t plan to spend the money all at once. However, once a HELOC’s draw period ends and the repayment starts, you’ll often face higher monthly payments or a large balloon payment, which can be tough to budget for.
- Home equity loan: A home equity loan could be a good option if you need a large sum all at once, such as for a kitchen or bathroom renovation project. Like a HELOC, it’s secured by your property, but you get the money all at once and pay it off in installments.
No matter what type of loan you choose, it’s important to consider your options carefully before using your home as collateral in any way. Getting an FHA cash-out refinance or other home loan for a short-term purpose, such as paying off credit card debt, is a risky move if you don’t have enough income to make the loan payments. But unlocking your home equity to make investments, such as upgrades that increase the value of your home, or to launch a new business could prove wise.
Trying to decide whether an FHA cash-out refinance makes sense for you? Talk to a local Finance of America Mortgage Advisor today to learn more about your options.