What is an FHA Cash Out Refinance?
There are two primary FHA refinance loan programs; the streamline refinance and the FHA cash out refinance. The FHA streamline refinance program refinances a mortgage to a lower rate with little documentation. But it doesn’t allow for any cash to the borrower.
The FHA cash out loan provides cash-in-hand to the borrower. You open a loan with a bigger balance than what you currently owe, and the excess proceeds go to you. Because it’s a riskier product for lenders, the FHA cash out loan requires more documentation than does an FHA streamline.
Benefits of an FHA Cash Out Refinance
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
- Home improvement
- Education costs
- Buying a new car or paying off a car loan
- Consolidating credit card balances
- Creating a personal cash cushion or to invest.
For example, if you owe $100,000 on your home you could open an FHA cash out loan for $150,000, assuming your home has adequate equity and you qualify for the loan. If closing costs were $5,000, you could end up with an extra $45,000 in your pocket.
Secondary to receiving cash out, these loans may be used to simultaneously lower the rate and/or change the loan term, i.e. from a 30 year fixed to a 15 year. You could even change an adjustable rate mortgage to a steady fixed rate loan.
FHA Cash Out Refinance Credit Scores And LTV
Compared to conventional cash out loans, FHA cash out loans have relaxed guidelines, allowing 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% (the same as a 15% down payment). So, in theory, you need a 500 credit score to qualify.
However, most lenders will require a much higher credit score since cash out financing is more carefully approved than even a home purchase. So, you’ll probably need a minimum score between 600 and 660 to qualify for FHA cash out.
FHA cash out maximum loan-to-value is 85% of the home’s current value (a new appraisal is required). Compare that with a maximum conventional cash out LTV of 80%. The higher limit is why many homeowners choose FHA instead of conventional. Here’s an example:
- Current value: $250,000
- Existing loan: $187,500
- Maximum conventional cash out loan: $200,000 (about $10,000 cash to the homeowner after paying off the existing loan and closing costs)
- Maximum FHA cash out loan: $212,500 (about $21,000 to the homeowner after loan payoff/closing costs)
The extra $11,000 in this case might be enough to make the homeowner choose the FHA cash out option.
Compare Conventional Cash Out and FHA Cash Out Refinances
FHA cash out loans also have their disadvantages. All FHA loans require both an upfront mortgage insurance premium and a monthly insurance premium. The upfront mortgage insurance premium is 1.75% of the loan amount. For a $200,000 loan, that’s $3,500 in additional principal tacked onto your loan amount.
Additionally, FHA requires monthly mortgage which would be 0.80% of the loan amount per year on a loan with an 85% loan-to-value. That’s $67 per month for every $100,000 borrowed. Also, this monthly mortgage insurance is now payable for 11 years rather than a mimumum of 5 years, after FHA mortgage insurance changes implemented on June 3, 2013.
Because of these extra costs, you should consider a conventional cash out refinance if your home has significant equity, as conventional loans at or below 80% loan-to-value do not require upfront or monthly mortgage insurance.
FHA Cash Out Refinance Guidelines
The FHA cash out refinance requires sufficient income to qualify for the new loan. Borrowers will verify their income with at least two most recent paycheck stubs from their employer showing current and year to date earnings, W2 forms from the last two years and in many instances, the two most recent 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 a brand new 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 85 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.
The minimum credit score for all FHA loans is 500. While there are no minimum credit score established by the FHA for cash out loans specifically, lenders will typically have their own internal requirements that are much higher than the minimum. The minimum credit score minimum requirement for an FHA cash out refinance is usually between 620 and 680. Check with a lender to see if your FICO is high enough.
FHA Cash Out Requirements
Occupancy. FHA cash out refinance loans are for owner-occupied properties only and cannot be used for rental properties.
Mortgage Payment History. To qualify for an FHA cash out, you may not have more than one 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 of the home. 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 $212,500 (85% of $250,000).
Affordability. 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 debt. 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 could 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.
Questions and Answers about the FHA Cash Out Loan Program
How much lower does my new rate have to be in order to qualify for an FHA cash out loan? 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.
Is there any way to eliminate the mortgage insurance premium on an FHA loan? 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.
Can I refinance my conventional mortgage into an FHA cash out loan? Yes, you may. However, the FHA cash out limit is 85 percent of the value of the home and requires a mortgage insurance premium to be paid. Consider the additional closing costs with an FHA cash out loan and compare the FHA option with a conventional loan.
I’m not sure how much cash out I need. How do I determine that? Your FHA loan will be limited both by the 85 percent loan to value as well as your local loan limits established by FHA. With that limitation in mind, you should figure out on paper how much cash you need for whatever need you are trying to fill. Tell you 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.
How late can a payment be in the past 12 months and still qualify? 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.
I bought my property four months ago and I think it’s worth a lot more now. Can I refinance? Properties owned less than six months are not FHA cash out eligible. 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 so in such a short period of time.
I’m Ready to Apply for an FHA Cash Out Mortgage
An FHA cash out refinance can be a great idea when you’re in need of cash for any purpose. With today’s low rates, this loan a very inexpensive way to borrow money to achieve your goals.