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FHA Cash-Out Refinance Loans: What They Are and How They Work
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If you need to tap home equity but your credit scores aren’t very high, an FHA cash-out refinance may be worth considering. Loans insured by the Federal Housing Administration (FHA) are easier to qualify for than other loan programs but are more expensive. Understanding how an FHA cash-out refinance works and the costs involved will help you decide if it’s the best option to access extra funds.
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What is an FHA cash-out refinance?
An FHA cash-out refinance is an FHA loan option that allows you to borrow more than you currently owe and pocket the difference between the two loans in cash. You can use the money in a variety of ways, including:
- Funding home improvements
- Consolidating high-interest-rate debt
- Covering higher education expenses
- Starting a business or side hustle
How to get an FHA cash-out refinance
The process for an FHA cash-out refinance is similar to other cash-out refinance loans:
- Shop around for the best rate with FHA-approved lenders.
- Provide proof of your income for the past two years and have your credit report and scores pulled.
- Lock in your interest rate (it’s not guaranteed until it’s locked in).
- Have your home appraised. One caveat: FHA appraisals are more expensive with more stringent property requirements than conventional appraisals.
- Finalize your loan figures on your closing disclosure and provide any final documents.
- Sign your paperwork and get your cash.
FHA cash-out refinance requirements
To qualify for an FHA cash-out refinance:
- You must refinance a principal residence. The FHA only allows you to tap equity on a home you live in.
- You’ll need to prove you’ve lived in the home for 12 months or longer. You must have lived in your primary residence for the last year before you’re eligible for an FHA cash-out refinance.
- You must have made on-time mortgage payments the past 12 months. Payments must have been made within the month due. If you own your home free and clear, you may qualify for a cash-out transaction.
- You can’t borrow more than 80% of your home’s value. Homeowners are required to have a maximum 80% loan-to-value (LTV) ratio. An LTV ratio is the percentage of your home’s value that is financed by the mortgage.
- Your minimum credit score must be at least 500. The credit score minimum is much lower than the 620 typically required for a conventional cash-out refinance. The catch: You’ll have a higher interest rate and pay for FHA mortgage insurance (mortgage insurance isn’t required on conventional loans if you have at least 20% equity).
- You can’t have any unpaid federal debt. FHA-approved lenders are required to use the CAIVRS database to verify you don’t have any defaulted debt (like student loans or federal judgments) in your credit history.
- Your DTI ratio should be 50% or less, but exceptions are possible. Your debt-to-income (DTI) ratio, or the percentage of your gross monthly income used to repay debt (including your mortgage) shouldn’t exceed 50%, but a higher DTI may be approved if you have high credit scores and proof of extra mortgage reserves.
- Your loan amount must stay within FHA loan limits. You won’t have quite as much borrowing power as conventional loans due to FHA loan limit restrictions. Use the FHA’s loan limit search tool to find the limit in your area.
- You must pay two types of mortgage insurance. To protect lenders from the risk that you might default on your loan, FHA borrowers pay two types of mortgage insurance. The first is an upfront mortgage insurance premium (UFMIP) of 1.75% of your loan amount, which lenders typically add to your mortgage balance at closing. You’ll also pay an ongoing mortgage insurance premium (MIP) ranging from 0.45% to 1.05%, depending on your loan term and down payment. MIP is charged annually, divided by 12 and added to your monthly mortgage payment.
How much money can you get from an FHA cash-out refinance?
You can borrow up to 80% of your home’s value with an FHA cash-out refinance. Here’s an example, assuming your current home is worth $350,000 and you owe $250,000 on your existing mortgage:
- $350,000 x 80% = $280,000 maximum FHA cash-out loan amount
- $280,000 – $250,000 current loan balance = $30,000 cash back to you
Pros and cons of an FHA cash-out refinance
| Pros | Cons |
|---|---|
You’ll qualify with lower credit scores | You’ll pay higher mortgage insurance premiums |
You’ll qualify with a higher DTI ratio | You can’t take cash out unless the home is your primary residence |
You can use the funds for almost any purpose | You won’t be able to borrow as much as a conventional loan |
You can deduct interest on funds used for home improvements | You’ll reduce the amount of available equity in your home |
Alternatives to an FHA-cash out refinance
If you’re not quite sold on an FHA cash-out refinance, here are some other financing options.
- Conventional cash-out refinance.With a 620 credit score and DTI ratio below 50%, you might benefit from a conventional cash-out refi. Don’t forget: You won’t need mortgage insurance if you borrow 80% or less of your home’s value.
- VA cash-out refinance.If your military service makes you eligible for a loan backed by the U.S. Department of Veterans Affairs (VA), you can borrow up to 90% of your home’s value with a VA cash-out refinance.
- Home equity loan.A home equity loan allows you to take out a second mortgage in a lump sum with fixed monthly payments. You can keep your current mortgage loan, but you’ll have two house payments each month.
- HELOC.A home equity line of credit (HELOC) is a revolving credit line secured by your home. It works like a credit card: You only repay the portion of the credit line you borrow, plus interest. You can access and reuse the credit line during a set period, usually 10 years. After that, the remaining balance is repaid in equal installments.
- Fixer-upper loans.If the sole purpose of your refinance is to make home improvements or renovations, consider a Fannie Mae HomeStyle® Renovation loan or an FHA 203(k) rehabilitation loan. You may be able to borrow more than a regular cash-out refinance, since the lender uses the “after-improved” value to determine your loan amount.
- Reverse mortgage.If you’re at least 62 years old, you may be able to tap equity without making a mortgage payment through a reverse mortgage. You’ll need at least 50% equity in your home.
- Personal loan.With higher interest rates than most mortgage loans, a personal loan can be a more expensive way to borrow money. However, if you don’t want to put your home at risk of foreclosure if you default, it may be a safer option than the others mentioned above.
Frequently asked questions
How much are closing costs on an FHA cash-out refinance?
FHA closing costs range from 2% to 6% of your loan amount, depending on your loan’s size.
What happened to the 85% maximum LTV FHA cash-out requirement?
In August 2019, the FHA announced it was reducing the maximum LTV ratio allowed on cash-out refinances from 85% to 80%.
Can I deduct the mortgage interest paid on my cash-out refinance?
Yes, as long as the cash was used to improve your home.
How do I get rid of FHA mortgage insurance premiums?
The only way to quickly get rid of FHA mortgage insurance premiums is to refinance into a conventional loan. Keep your LTV ratio below 80% to avoid private mortgage insurance. Otherwise, you can keep paying MIP on your FHA cash-out refi loan for 11 years, after which point it will be removed.