Tapping into your home’s equity is possible with an FHA cash-out refinance. How do you do it, though? What do you need to qualify?
We cover these questions and more in this guide.
What is an FHA Cash-Out Refinance?
First, let’s look at what the FHA cash-out refinance is, so you understand it. When you take out a cash-out refinance, you refinance your home for more than what you owe now. The amount you can take out depends on the amount of equity you have in the home. The difference between what you owe in principle and the new amount goes to you.
Some homeowners take the amount in cash. They use it for other expenses, such as home remodeling, college expenses, or a wedding. Others have the lender pay specific creditors directly. This way the homeowner is not given the money and can’t give into the temptation to use the money. Sometimes this is a requirement of the loan parameters, depending on your debt ratio and the reason for the loan.
The Maximum LTV
When you took out your original FHA loan, you were able to borrow up to 97.5% of the property’s value. That’s not the case with the FHA cash-out refinance. Now, you can only borrow up to 85% of the home’s value. Giving you cash above and beyond what you owe is risky for the lender and the FHA. They need to minimize that risk by lower the LTV allowances.
Here’s how it works.
You have a current FHA loan with an outstanding balance of $150,000. Your home is currently worth $215,000. You currently have an LTV of 70%. You decide you want to tap into your 30% equity. You would be able to borrow up to $32,750 or 85% of the home’s value.
If your home was only worth $200,000, this number would be different. You would only be able to borrow $20,000 to remain at the 85% LTV.
Credit Score Requirements
Just like with your original FHA loan, the FHA is lenient when it comes to minimum credit score requirements. Even on the risky cash-out refinance, they allow scores as low as 500. But, in reality, most lenders will not allow a credit score that low. Because the lender has the final say in the requirements, you can expect minimum credit score requirements around 660 for an FHA cash-out refinance.
If you compare the minimum credit score to conventional loans, you’ll see some similarities. In general, Fannie Mae allows credit scores as low as 620 for a cash-out refinance. But again, most lenders won’t allow that. They would prefer a score of around 680.
Seasoning pertains to how long you have owned the home. Trying to refinance too soon could backfire on you. Lenders like to see consistent mortgage payments over a long period of time. In general, this means no late payments in the last year.
However, if you have owned your home for less than 12 months, you can get away with an on-time payment history for the last 6 months. However, if you do refinance before you have owned the home for 12 months, you cannot secure a new appraisal. The lender must use the original appraisal on the property.
This is where refinancing too soon could backfire on you. If you were banking on taking advantage of your home’s appreciation, you’ll have to wait a little longer. Refinancing before that 1-year mark will leave you with a lower value and less money in your pocket.
Dealing with a Second Mortgage
If you have a second mortgage on the property, it will play a role in your ability to do the FHA cash-out refinance. Typically, the FHA requires the second mortgage to be subordinated. This earns the second mortgage lender agrees to keep the second lien position even with the refinance. Typically, when there is a second mortgage and you pay off the first, the second lien automatically takes first position. No lender will allow that to happen if you refinance the 1st mortgage, though.
The only way you can include the 2nd mortgage in the refinance is if the total LTV is less than 85%. In other words, the money you borrow to pay off the 2nd mortgage plus any cash out you need cannot exceed 85%.
FHA Cash-Out Refinance Interest Rates
Something you should take into consideration though is the higher interest rate you will likely pay. Because a cash-out refinance is risky for the lender, they usually charge more interest. This gives them a little more money in their pocket while you do make payments. If you default on the loan, they at least made a little more money on your loan than they did when you had the purchase FHA loan.
There are not any standard rates a lender must charge you, though. You should shop around with various lenders to see what they can offer you. One FHA lender may have a much higher rate for you than another. It doesn’t hurt to find out – check with at least 3 lenders to make sure you get the best deal.
The FHA cash-out refinance gives you access to the equity in your home. Even though you are limited to 85%, it’s still a good program. They allow lower credit scores and higher debt ratios than conventional loans allow. This makes it easier to qualify for FHA cash-out refinancing.