Thinking about some home improvements like putting on an addition or remodeling a kitchen? You might want to consider an FHA cash-out refinance. The FHA cash-out refinance loan allows you to refinance your mortgage, typically at a lower interest rate, and pull out up to 80% of the equity you have in your home for remodeling or home improvements (as well as debt consolidation and other reasons). Equity is the difference between the current value of your house and the amount you owe on the mortgage.
- The FHA cash-out refinance works the way other cash-out refinance loans work. If you owe $200,000 on your mortgage, for example, you might get a new loan for $225,000. $200,000 of it pays off your previous loan and the $25,000 is yours for your home improvement project.
- FHA loans are good for people with lower credit scores and are more lenient about debt ratios than other loans.
- An FHA-cash-out refinance allows you to borrow money to improve your home at today’s low-interest rates by using the equity built up in your house.
How Much Money Can you Cash Out?
The amount of money you can take in an FHA cash-out refinance will depend on the amount of equity you have built up in your home. But you must have at least 20% of equity left over after you refinance and take some cash out. In other words, you cannot take all the available equity.
You can get an idea of how much your home is worth is by using sites like Zillow for an estimate. Then subtract what you owe on your mortgage from your home’s estimated value. If you owe $250,000 but your home is now worth $450,000, that leaves you with $200,000 of equity. You could take a $360,000 total loan, which is 80% of your home’s value. Of that, $250,000 will go to pay off your mortgage, and $110,000 minus closing costs would be available for your cash out.
Who Can Qualify for an FHA Cash-Out Refinance?
According to FHA guidelines, applicants must have a minimum score of 580 to qualify. However, most lenders who provide FHA cash-out refinance loans set their limits, which typically need a minimum score in the 600-620 range. Some lenders will use the middle score if there are three different scores. Others may require that the lowest score qualifies. Your lender is the best source of information on their credit score requirements.
To make sure you can afford your new mortgage payment without getting in over your head, the FHA has guidelines on the debt-to-income ratio you need to qualify. This can be calculated in several different ways but essentially, it’s how much debt you have compared to your gross monthly income. The two different methods of calculating this include:
- Mortgage payment to income is calculated by dividing your total housing payment (principal, interest, taxes, insurance, HOA fees, etc.) by your gross monthly income. This number must be lower than 31%.
- Total fixed payment to income is calculated by adding up your total mortgage payment (principal, interest, taxes, insurance, HOA fees, etc.) as well as all your recurring monthly expenses such as student loans, credit card debt, auto loans, etc. Divide that amount by gross monthly income. This is your debt ratio and needs to be under 43%.
Maximum Loan to Value
A loan-to-value or LTV is the amount of equity you have built up in your home. So, for example, if you have a mortgage for $315,000 but your home is worth $500,000, the difference of $185,000 is your LTV. To qualify for an FHA cash-out refinance, the amount you owe on your mortgage cannot be greater than 80% of your home’s value. For instance, if your home is worth $500,000, 80% is $400,000 ($500,000 X 0.8). If you owe more than $400,000 you wouldn’t qualify for the FHA cash-out refinance.
Time in Residence
The FHA also has a length of residence qualification to qualify for the cash-out refinance loan in which you must live in your home and have had the mortgage that you will be refinancing for at least 12 months.
Mortgage Payment History
To be approved for the FHA cash-out refinance, you also must have an on-time payment history on your mortgage for the past year. That means you can’t have any late payments within the past twelve months.
FHA cash-out refinances typically have low-interest rates. On average, they’ll be 10-15 basis points (0.10-0.15%) lower than conventional cash-out refinance loans. However, because the FHA offers more flexibility with credit scores and debt ratios compared to conventional loans, the loan requires you to have mortgage insurance with upfront and monthly mortgage insurance premiums (1.75% of the new loan amount upfront and 0.85% of the loan amount annually in 12 payments per year).
The Bottom Line
Despite the added insurance, if you need a cash-out refinance loan and have a higher debt-to- income ratio or lower credit scores, the FHA cash-out refinance is a good product to examine. For those with good credit and 20% equity, a conventional cash-out refinance would be more cost-saving.
What is a FHA Cash-out Refi Loan?
An FHA cash-out refinance loan is a refi of an existing loan backed by the Federal Housing Authority. While FHA cash-out refi loans act just like a conventional refi loan they must conform to certain loan-to-value and debt-to-income standards per policies and underwriting standards mandated by the FHA.
What is a debt-to-income ratio?
A debt-to-income ratio is simply a percentage that is calculated by dividing your total debt obligations (mortgage, car loan, personal loans, credit card amounts owed, student loans, etc.) by your gross income. The FHA requires borrowers to have a debt-to-income ratio of 43% or less. Another method of calculation is to simply take all housing-related expenses (mortgage principal, interest, taxes, insurance) and divide by gross income. That ratio can not exceed 31% according to FHA standards.
What is a loan-to-value ratio?
A loan-to-value ratio calculation of how much of a cash-out refi loan will be made by a lender based on the equity a borrower has in their home. FHA underwriting standards require that refi loans must conform to LTV of 80% or less of the appraised value of the home. So, if a borrower wanted to refinance a mortgage on a home worth $500,000 the maximum refi loan would be $400,000.