FHA Cash-Out Refinance: Access Your Home Equity
Editor’s note: Starting September 1, 2019, HUD, the administrator of FHA loans, reduced the maximum FHA cash-out refinance loan-to-value to 80%, down from 85%.
As the name implies, the greatest benefit of an FHA cash-out refinance is to put extra cash in the borrower’s pocket. These funds can be used for any purpose such as:
Compared to conventional cash-out loans, FHA cash-out loans have relaxed guidelines that allow borrowers with lower credit scores and higher debt-to-income ratios to qualify.
The minimum credit score for FHA loans is 500, assuming a 10% down payment. FHA cash-out refinances require 15% equity (the same as a 15% down payment). So, in theory, you need a 500 credit score to qualify.
However, most lenders require a much higher credit score since cash-out financing is riskier than even a home purchase. You’ll probably need a minimum score between 600 and 660 to qualify for FHA cash out.
FHA cash-out maximum loan-to-value (LTV) is 80 percent of the home’s current value (a new appraisal is required) compared to the maximum conventional cash-out LTV of 80 percent. The higher limit is why many homeowners choose an FHA refinance instead of conventional.
After paying off the existing loan plus closing costs, homeowners would receive about $10,000 cash for a conventional cash out versus $21,000 for FHA cash out. That extra $11,000 may be enough for many homeowners to choose the FHA cash-out option.
The FHA cash-out refinance requires sufficient income to qualify for the new loan. Borrowers must verify their income with at least two most recent paycheck stubs from their employer showing current and year-to-date earnings, W-2 forms from the last two years, and in many instances, the two most recently filed federal income tax returns.
Asset verification in the form of bank and investment statements are typically not a requirement for an FHA cash-out refinance loan as no funds are needed in order to close the transaction. However, this does not mean the FHA lender cannot request bank statements as part of their internal underwriting guidelines.
The FHA lender evaluating an FHA cash-out loan application will require an appraisal report on the subject property. The value on the appraisal is used to determine the maximum allowable loan amount for an FHA cash-out loan. Currently, the maximum loan amount for an FHA cash-out refinance is 80 percent of the value of the property as long as the home was purchased more than one year ago and does not exceed FHA’s county-by-county loan limits.
Occupancy. FHA cash-out refinance loans are for owner-occupied properties only and cannot be used for rental properties.
Payment history. To qualify for an FHA cash out, you may not have more than one mortgage payment that was more than 30 days late in the last 12 months. The existing mortgage must be at least six months old and have a verified payment history, usually determined by the borrower’s credit report.
Length of ownership. If you’ve lived in the home less than a year, the FHA lender will use the lower of the appraised value or the original purchase price of the home to determine your maximum loan amount. For example, if you purchased the home less than a year ago for $250,000 and it now appraises for $270,000, your maximum loan amount will be $200,000 (80 percent of $250,000).
Debt-to-income ratio. FHA cash-out loans require the borrower to meet existing debt-to-income ratio guidelines. The maximum FHA debt ratio guidelines are 29 and 41, but may be higher in certain instances. The first ratio, 29, is the housing ratio calculated by dividing the total housing payment with gross monthly income. The housing payment includes principal and interest, taxes, insurance, monthly mortgage insurance premium and any condo or homeowner association fees. For example, if the housing payment is $2,000 and monthly income is $7,000, the housing debt ratio is 28.5%.
The total debt ratio limit is 41 and includes the housing payment plus additional monthly credit obligations. Additional credit obligations include credit card payments, automobile or student loans, and installment debts. Other qualifying debt includes spousal or child support payments. This number does not include utilities, car insurance, or other non-debt payment types.
A borrower with $7,000 per month income may have a house payment up to $2,030 per month and monthly credit obligations of up to $840 per month.
Co-borrowers. Non-occupant co-borrowers are allowed on an FHA cash-out refinance loan as long as the non-occupant co-borrowers are on the original note. Non-occupant co-borrowers may not be added to the loan application to help the primary borrower qualify.
There is no requirement that your new rate be lower by a specific amount, but the lender may require that there be a tangible benefit to you by refinancing. This benefit may be the cash itself, a lower payment, reducing your loan term, or changing from an adjustable rate or hybrid loan into a fixed-rate mortgage.
The upfront FHA mortgage insurance is always required and cannot be changed. However, your lender may be able to adjust your interest rate upward and give you a credit from the excess profit from the loan, to help pay the 1.75% upfront mortgage insurance premium.
Your FHA loan will be limited both by the 80 percent loan-to-value ratio as well as your local loan limits established by FHA. With that limitation in mind, figure out how much cash you need for your specific goal. Tell your loan officer that number, and he or she will work backward, figuring in closing costs, to come to a sufficient loan amount (assuming all loan qualification factors make the desired loan amount possible).
If you only want to pull cash out of your property, but want to avoid the extra costs of a full refinance, consider obtaining a home equity loan instead. Many local and national banks are now offering second mortgages, which are a cheaper option than refinancing.
Mortgage payments are typically due on the first of the month and considered past due after the 15th of the month. Only payments that are more than 30 days past the original due date are considered “late.” Any payments made before 30 days past the due date are not counted against you, as long as your lender received the payment on time and did not report your payment late to the major credit bureaus.
Properties owned less than six months are not eligible for a FHA cash out refinance. You must wait at least six months. However, if your property has appreciated significantly in six months, the FHA lender will use the original sales price of the property or a new appraisal, whichever is lower. If you put the minimum 3.5 percent as a down payment six months ago, a lender will question why the property value has increased in such a short period of time.