If you’re in the process of mapping out a home remodel, looking for ways to consolidate credit card debt or preparing to send a child to college, you might be pressed for cash. Thankfully, if you have equity in your home, a cash-out refinance backed by the Federal Housing Administration (FHA) may be the perfect solution.
FHA cash-out refinances come with numerous benefits, such as less strict credit requirements and competitive interest rates. Let’s take a closer look at how this refinance program works and the guidelines that many lenders use.
What Is An FHA Cash-Out Refinance?
An FHA cash-out refinance is a type of refinancing that allows borrowers to replace their existing mortgage with a new FHA loan of a larger loan amount, allowing them to receive the difference in a lump sum of cash. The funds can be used for numerous things, such as:
- Home improvements and remodels
- Debt consolidation
- Consolidating a first and second mortgage
- Student loan refinancing
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How Does An FHA Cash-Out Refinance Work?
Similar to a conventional cash-out refinance, the FHA option allows you to replace your current mortgage and convert your home equity into usable funds. However, to qualify, you’ll need to meet minimum home equity requirements. You’ll also need to meet your lender’s standards regarding your income, credit and loan amount. We’ll cover these requirements in more detail below.
After the loan is approved and the refinance is complete, you will get a new interest rate, loan term and monthly payment amount. It’s worth noting that you don’t have to start with an FHA loan to get an FHA refinance. Even if you originally purchased your home with a conventional loan, you can still choose to refinance with an FHA mortgage.
Many borrowers choose to refinance into an FHA loan because they’re backed by the Federal Housing Administration, minimizing risk for lenders and allowing them to use less stringent loan qualification parameters, such as lower credit score requirements.
Once you’re ready to refinance, you can fill out and submit a Uniform Residential Loan Application to the lender of your choice. Most lenders offer FHA loans, so do your research into lender terms and reputations before you apply.
FHA Cash-Out Refi Example
Here’s an example of how a cash-out refinance works. Let’s say you bought a house for $265,000 with an FHA loan. You put $15,000 down and took out a mortgage for $250,000. You’ve paid $70,000 on your mortgage since you first bought the home, putting your remaining loan balance at $180,000. And now your home is worth $275,000.
Based on these numbers, you can refinance with a cash-out mortgage for up to 80% of the current value of your home, minus what you owe on your mortgage balance.
$275,000 x .80 = $220,000, which is the maximum loan amount you can take out.
Let’s take that $220,000 and subtract your remaining balance of $180,000 which leaves you with $40,000 to take out as a lump sum when you close your loan.
FHA Cash-Out Refinance Requirements
If you’re intrigued by the potential benefits of an FHA cash-out refi, you might be wondering how to qualify. Much like your first mortgage, applying for a refinance will mean meeting various lender requirements, including:
- Credit score: Most private lenders have their own requirements for credit scores that can be closer to 580. However, the FHA requires a minimum credit score of 500 to qualify for a cash-out refinance.
- Debt-to-income ratio: Specific DTI requirements depend on your credit score and lender, but in general, it may be possible to be approved with a DTI exceeding 50%
- Loan-to-value: The loan-to-value (LTV) ratio represents the amount of equity you have in your home compared to its current value. To qualify for an FHA cash-out refinance, your LTV can’t exceed 80% of your home’s value.
- Payment history: To be approved for an FHA refinance, you can’t have had any late mortgage payments over the previous 12 months.
- Length of residence: You also need to have lived and own your residence for a minimum of 12 months to qualify.
FHA Cash-Out Refinance Loan Limit Guidelines
Besides making sure you meet your lender requirements, you’ll also need to verify you can get the loan amount you want.
The FHA uses the area you live in and the number of units you’re purchasing to determine FHA loan limits, which often change annually. In 2023, loan limits across the country increased. The lower limit for a one-unit property was $472,030 and the maximum was $1,089,300. For a cash-out refinance, you’ll need to meet local FHA loan limits and loan-to-value minimums to qualify.
To find the specific loan limit in your area, we recommend the FHA mortgage limits tool provided by the U.S. Department of Housing and Urban Development (HUD).
How Much Equity Can You Access With An FHA Cash-Out Refinance?
Like most cash-out programs, you won’t be able to take out 100% of your existing equity. Instead, your lender will require you to leave 20% behind when refinancing your current mortgage. Let’s circle back to our example from earlier. By refinancing and bringing the loan amount up from $180,000 to $250,000, you have created an excess of $70,000 to tap into.
However, loan-to-value limits state that the cash-out amount can’t exceed 80% of the home’s appraised value. So, assuming your home’s value is sitting around $250,000, you’ll be required to leave at least $50,000 (20% of the home’s value) untouched. That leaves you with around $20,000 to cash out, though you’ll still need to pay closing costs, which typically cost 2% – 6% of the total loan amount.
Advantages And Disadvantages Of FHA Cash-Out Refinances
Before applying for an FHA refinance, we recommend reviewing all the potential pros and cons listed below to determine if this loan option is right for you.
Advantages
As we’ve discussed, FHA cash-out refinances can have several distinct advantages, including lower interest rates and the opportunity to tap into equity that can be used to fulfill any of your heart’s desires. And the lower credit score requirements that make it easier to qualify for certainly don’t hurt either.
FHA loans are also popular due to their competitive interest rates. Since lenders generally face less risk, borrowers may have a better chance of securing a lower interest rate with an FHA loan compared to a conventional one.
Disadvantages
But for all their advantages, there are a few disadvantages associated with FHA cash-out refinances as well. This is primarily because refinancing means taking on additional debt and reducing your available home equity.
Another downside is having to pay mortgage insurance premiums (MIP), which are required on all FHA loans. This type of mortgage insurance requires an upfront payment as well as smaller monthly payments.
FHA Cash-Out Refinance Alternatives
If you want to use your equity or change your loan terms without using an FHA cash-out refinance, you’re in luck. There are several alternatives homeowners can choose from:
- FHA Streamline refinance: This type of refinance loan allows FHA borrowers to replace their loan without an appraisal. However, you won’t be able to access your equity with this option.
- Conventional cash-out refinance: If you have good credit and substantial equity, a conventional cash-out refinance may allow you to access funds and remove your FHA mortgage insurance all at once.
- Home equity loan or HELOC: While a refinance allows you to change your mortgage rate and term, you might want to keep your current home loan intact. If that’s the case, you can use a home equity loan or home equity line of credit (HELOC) instead.
The Bottom Line
Cash-out refinances present a unique opportunity for homeowners to leverage the equity in their homes, allowing them to utilize that money for any number of things. With an FHA cash-out refinance, this process may be made even easier due to less strict loan qualification requirements.
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Victoria Araj
Victoria Araj is a Staff Writer for Rocket Companies who has held roles in mortgage banking, public relations and more in her 15-plus years of experience. She has a bachelor’s degree in journalism with an emphasis in political science from Michigan State University, and a master’s degree in public administration from the University of Michigan.
