FHA loans aren’t just for first-time homebuyers buying a home. You can use FHA financing when you want to refinance, even if you are taking cash out of your home’s equity. You get the same flexible guidelines the FHA offers homebuyers, which is good news when you need to pay your home’s equity. Many programs have strict guidelines making it harder to get the money you need, but the FHA makes it a little more flexible.
The Maximum Loan-to-Value Ratio
When you apply for a cash-out refinance, the lender will restrict your loan-to-value ratio more than they would if you applied for a rate/term refinance. This is because when you tap into the equity in your home, you become a riskier borrower.
This isn’t to say that you are a ‘bad borrower,’ it’s just a higher risk for the lender because you borrow more than you owed originally. Let’s say you had an outstanding balance of $100,000, but now you borrow $150,000. You are now a riskier borrower.
Just how much can you borrow with the FHA loan? The FHA allows up to an 85% LTV. If your home is worth $300,000, then you can have as much as $255,000 in total loan debt. Keep in mind, this includes your first mortgage. If your first mortgage still has $150,000 outstanding, you can borrow an additional $105,000 if you wish.
The Exception to the Rule
If you decide to tap into your home’s equity before you’ve had your FHA loan for 12 months, you cannot use the current value of the home to figure out your LTV. Instead, you must use the original appraised value of the home. In the above example, let’s say you bought the home for $250,000. That limits your loan amount to $212,500 rather than $255,000.
If you try to take a cash-out loan before you own the home for 12 months, you will also have to make sure you have timely mortgage payments for the time you’ve owned the home. Having late payments will not work in your favor as you have not established any type of history, so the lender doesn’t know if you are a good risk or not.
The Rate/Term Refinance LTV Limits
You might wonder how the LTV limits change when you take out a rate/term refinance. In this case, it’s just like when you purchased the home. You only need 3.5% equity in the home. In other words, you can borrow as much as 96.5% of the home. The rate/term refinance only allows you to reduce your interest rate or change the term of your loan. You cannot take cash out of the home for any reason.
The guidelines for the rate/term refinance are slightly more flexible than the cash-out loan because it’s less risky. If you refinance to lower your interest rate, you put yourself in a better situation. You probably have a lower payment, which increases your likelihood of making your payments on time. If you reduce the term, your payment may increase, but you will pay the loan off in a shorter amount of time, putting the lender in a good position.
If you need a cash-out refinance, the FHA loan offers a higher LTV than conventional loans, but a lower one than VA loans (they allow 100%). You only need a 580 credit score and stable income/employment to qualify. Of course, a lender may add more requirements or ask why you are taking cash out of the home. The lender has the discretion to decide if they want to fund the loan or not based on your answers.