You love your home, but you're sick of the popcorn ceilings and want to replace them. Or perhaps your child just got into their dream school and you want to help with the tuition. Whatever the case may be, your home can be a useful resource when you need a large amount of money. If your home's value is higher than your mortgage balance, you can use it to take out an FHA cash-out refinance loan.
- FHA cash-out refinance loans are insured by the Federal Housing Administration but issued by private banks, credit unions, and online lenders.
- You can refinance your mortgage for more than you owe and get the difference in cash.
- The maximum loan-to-value ratio for FHA cash-out refinance loans is 80%.
- You must have a credit score of at least 500 to qualify for a loan, but higher credit scores will get better terms.
How FHA Cash-Out Refinance Loans Work
If you own a home and have accumulated equity in it—meaning the property is worth more than you owe on the mortgage—you can use an FHA cash-out refinance loan to take advantage of that equity.
In a cash-out refinancing, you take out a new mortgage for more than you owe on your current mortgage (which is then paid off), and the lender gives you the difference as a lump sum. The money can be used however you want; there are no restrictions on its use.
FHA cash-out refinance loans are insured by the Federal Housing Administration. Because of that government backing, you may be eligible for lower rates than you'd get with other mortgage refinancing, and you may qualify even if you have less-than-perfect credit.
Who Is Eligible for an FHA Cash-Out Refinance Loan?
If you're interested in refinancing your mortgage, you can use an FHA cash-out refinance loan even if your current home loan isn't an FHA mortgage.
However, there are some eligibility requirements you have to meet in order to qualify for a loan:
- Type of Home. FHA cash-out refinance loans can only be used for owner-occupied principal residences. Investment properties and vacation homes are not eligible.
- Time in Home. You must have owned and occupied the home for at least 12 months.
- Payment History. For the past 12 months, all of your mortgage payments must have been made within the month due.
- Loan-to-Value Ratio (LTV). The maximum loan-to-value ratio, or LTV, for an FHA cash-out refinance loan is 80%. That means the amount you owe on your existing mortgage cannot exceed 80% of the home's current value. For example, if your home is worth $200,000 and you owe $170,000 (an LTV ratio of 85%), you're ineligible for the cash-out refinance option.
- Credit Score. The minimum credit score you need for an FHA loan is 500. However, some FHA-approved lenders have higher score requirements. In general, you can qualify for lower interest rates if you have good to excellent credit, meaning a score between 670 and 850.
How Much Money Can You Get With an FHA Cash-Out Refinance Loan?
As mentioned, to qualify for a cash-out refinance loan with an FHA-approved lender, you must not owe more than 80% of your home's value. You must also maintain 20% equity in your home after refinancing. That limits how much of your equity you can "cash out."
To estimate how much money you can get, you'll first need to determine your home's current value. You can look at what similar homes in your area have sold for recently, ask a local real-estate agent for a ballpark estimate, or hire a professional appraiser for a more precise one. You can determine how much equity you have by checking your mortgage statement or mortgage amortization table, which will show how much you still owe.
For example, let's say your home is currently worth $250,000 and you owe $150,000 on your mortgage. Through a cash-out refinancing, you could borrow as much as $200,000—80% of your home's current value—after which you would still have 20% equity in the home, as required.
The new $200,000 mortgage will pay off the $150,000 remaining on the old one, leaving with you $50,000 in cash. Like other mortgages, FHA loans have closing costs, which will reduce how much money you walk away with. If, for example, your costs equal the median for FHA loans ($6,868), you'd be left with $43,132.
Pros and Cons of FHA Cash-Out Refinance Loans
Before applying for an FHA cash-out refinance loan, you'll want carefully consider the potential benefits and risks compared with other ways of borrowing.
- Low Interest Rates. FHA loans generally have very low interest rates—often under 4%. Compared with other forms of debt, such as personal loans or credit cards, that makes them a relatively inexpensive way to borrow.
- Low Credit Score Minimums. FHA loans tend to have lower credit score minimums than many other forms of credit. You can qualify for a loan with a score as low as 500.
- Larger Loan Amounts. Because you are borrowing against your home's equity, you can get more money with a cash-out refinance than you might be able to obtain through a personal loan or line of credit.
- Increased Debt. With a cash-out refinance loan, you're taking on a mortgage for more than you currently owe. That will mean higher monthly payments and greater risk of getting behind if you lose your job or face other financial difficulties.
- Your Home Is at Risk. As with other types of mortgages, your home will serve as collateral for the new loan, and the lender can foreclose on it if you default. With other, nonsecured loans, such as a personal loan or credit card, your home doesn't serve as collateral and isn't at risk in the same way.
- Closing Costs and Fees. When you apply for an FHA cash-out refinance loan, you will have to pay closing costs and fees, reducing your available cash by thousands of dollars. Other types of borrowing have fewer fees, although they may have higher interest rates.
If you decide that an FHA cash-out refinance loan is right for you, you can use the U.S. Department of Housing and Urban Development's database to find an FHA-approved lender in your area.
What Is an FHA Cash-Out Refinance Loan?
With an FHA cash-out refinance loan, you take out a larger mortgage to pay off your current one and receive the difference in cash. You can then use that cash for any purpose.
When Does an FHA Cash-Out Refinance Loan Make Sense?
An FHA cash-out refinance loan can be a relatively inexpensive way to borrow money for a major expense, such as home remodeling. FHA loans currently have an interest rate of about 4%, a small fraction of what you'd have to pay on credit card debt, for example.
What Are the Risks of an FHA Cash-Out Refinance Loan?
The primary risk is that by taking out a larger mortgage you are going deeper into debt. Your monthly mortgage payments will be higher and could conceivably become unaffordable if you lose your job or other sources of income. In a worst-case scenario, the lender could foreclose on your home and you could lose it.
What's the Most I Can Get From an FHA Cash-Out Refinance?
You can borrow as much as 80% of the current value of your home. For example, if your home is worth $300,000, the maximum would be $240,000. After you've paid off your existing mortgage, you can then receive the remaining money as a lump sum. So, if you borrowed $240,00 and your existing mortgage still has a balance of $140,000, you could "cash out" $100,000.