FHA Cash-Out Refinance Guide

A couple reviews documents while sitting in front of a laptop
•••

fizkes / Getty Images

An FHA cash-out refinance is an appealing option for homeowners who want to take advantage of today’s low rates to access their home equity and get extra cash for renovations or to pay off high-interest bills. These loans typically offer more relaxed requirements than conventional loans, which is a great benefit for homeowners with lower credit scores or excess debt who may not qualify for other types of cash-out programs.

We’ll explain how an FHA cash-out refinance mortgage works and outline the requirements and costs, and help you determine if it’s the right choice.

Key Takeaways

  • You need at least 20% equity in your home to qualify for an FHA cash-out refinance mortgage.
  • You must have lived in your home for at least a year (and made 12 on-time, consecutive payments).
  • Lenders may require a higher credit score than the typical FHA minimum.
  • The requirements are similar to a regular FHA mortgage.

What Is an FHA Cash-Out Refinance?

The Federal Housing Authority (FHA) does not lend money. It insures loans offered by private lenders that meet its guidelines. An FHA cash-out refinance works similarly to a traditional cash-out refi: You get a new loan that’s more than the amount you owe on your existing home loan. You pay off your old mortgage with the new loan, then pocket the difference. You’ll typically receive a lump-sum payment a few days after closing.

The maximum amount of cash you can get from an FHA cash-out refi depends on how much equity you have in your home.

The maximum loan-to-value (LTV) ratio for an FHA cash-out refinance is 80%. In other words, you can borrow up to 80% of your home’s value, as long as you have at least 20% in equity.

Say, for example, that your home is worth $300,000. You have $120,000 (40%) in equity and a loan balance of $180,000. The FHA cash-out refinance guidelines mean you can’t borrow more than $240,000 (80% of $300,000), James Goodwillie, co-owner of Brightleaf Mortgage in Richmond, Virginia, told The Balance by email.

Here’s how the numbers might work:

Current home value $300,000
Existing loan balance $180,000
Home equity $120,000
New FHA refi loan (max. 80% of home value) $240,000
Estimated closing costs $7,200
Max cash-out potential (refi loan less existing balance less closing costs) $52,800

In this scenario, the maximum amount of cash you could expect to get back is $60,000. However, if you decide to put some of the cash-out toward closing costs—which, in this example, are estimated at 3% of the amount borrowed ($7,200)—it would be even less. You’d be left with $52,800—less than half of the $120,000 in equity you had in your home. As you can see, it’s a good idea to run the numbers to determine if an FHA cash-out refinance is right for you.

FHA Cash-Out Refinance Qualifications

FHA cash-out refinance qualifications are similar to other FHA loan requirements. Your credit scores are important, as are your debt-to-income ratio, loan-to-value ratio, and payment history.

Credit Score

Generally, you need a minimum credit score of 500 to qualify for an FHA cash-out refinance. However, lenders may have their own requirements, possibly for higher scores. For example, Rocket Mortgages requires a FICO score of 580 and says your chances improve if your score is at least 620.

Debt-to-Income Ratio

Lenders will also consider your debt-to-income ratio—how much of your gross monthly income (before taxes) goes toward repaying debt (including your mortgage). Ideally, you’ll want that ratio to be as low as possible, but FHA-insured lenders’ requirements may be less stringent, allowing some wiggle room. Debt-to-income (DTI) ratio can be calculated in one of two ways:

  • Divide your total mortgage payment (which includes mortgage insurance, homeowners association dues, etc.) by your gross monthly income. If your mortgage lender uses this calculation and your credit score is 579 or lower (minimum 500), your maximum DTI ratio cannot exceed 31%.
  • Alternatively, lenders may add together your total mortgage payment and your recurring debts (such as credit cards, auto loans, student loans, etc.), then divide the sum by your gross monthly income. If your lender uses this calculation, and your credit score is 579 or lower, your total debt ratio cannot be higher than 43%.

In some situations, as long as your credit score is 580 or higher, your debt-to-income ratio can be as high as 50%. This typically applies to people with no discretionary debt, or who have other “compensating” factors, such as significant savings or whose housing costs won’t change much as a result of the refinance.

Loan-to-Value Ratio

You must have at least 20% equity in your home to qualify for an FHA cash-out refinance. Put another way, the maximum loan-to-value ratio (LTV) can’t exceed 80%.

Residency and Payment History

The home you’re refinancing must be your primary residence. In addition, you have to have lived in it for 12 months before you apply, and have made 12 consecutive mortgage payments in the month they were due—unless you own your home free and clear.

FHA Cash-Out Refinance Costs

The biggest downside to FHA cash-out refinance loans is that you’ll have to pay for mortgage insurance on your new loan. You’ll pay for upfront mortgage insurance, which is generally 1.75% of the new loan amount, and annual mortgage insurance, which typically comes out to 0.85% of the loan. When you add all these fees on top of the closing costs, doing an FHA cash-out refinance can get expensive, Goodwillie said. That said, FHA refinance rates are often lower than conventional loans, so taking on mortgage insurance might be worth it to get extra cash and a new, lower interest rate.

Your current mortgage does not have to be an FHA loan for you to qualify for an FHA cash-out refi.

Is an FHA Cash-Out Refinance Right for You?

What are the pros and cons of an FHA cash-out refinance, and how can you determine if it’s the right choice for you?

Pros

If your goal is to consolidate bills and work on paying down high-interest debt, an FHA cash-out refinance might make sense for you. In light of current low mortgage rates, the cash you borrow with an FHA cash-out refi will likely come with a cheaper rate than you would get with a credit card or personal loan.

You can also use the money to finance a home renovation project that could make your home more comfortable and more usable while increasing its value.

In addition, the qualification requirements for an FHA cash-out refinance are typically more lenient than those of other types of home loans. If you have a financial hardship such as a bankruptcy, foreclosure or short sale in your past, for example, you may be able to qualify for an FHA loan within two to three years.

Cons

On the downside, the FHA has lending limits; it caps the amount it will insure for a single county in each state. Depending on where you live, these limits may fall short of your needs if you need to take out a lot of cash. The type of home you live in, a single family versus a duplex, for instance, can also impact FHA lending limits.

The upfront and ongoing mortgage insurance premiums are also things to keep in mind when you’re considering an FHA cash-out refinance. You’ll need to decide if the benefits you’ll get from the refi justify these additional expenses.

In addition, like any refi, applying for an FHA cash-out loan comes with a lot of paperwork—comparable to the stack of documents you filled out when you got your original mortgage. So make sure you are prepared to spend the time you’ll need to get the loan.

Frequently Asked Questions (FAQs)

What companies offer FHA cash-out refinances?

Most FHA-insured lenders that offer traditional FHA loans also offer FHA cash-out refinance loans. The U.S. Department of Housing and Urban Development provides a lender list search you can use to find lenders in your area.

What documents do you need for an FHA cash-out refinance?

At minimum, you’ll typically need to provide the  following documents:


·      Driver’s license

·      Pay stubs

·      Tax returns

·      W-2 forms

·      Banking statements

·      Social Security number