FHA Cash-Out Refinance: What You Need to Know

If you need to tap home equity but your credit scores aren’t very high, an FHA cash-out refinance may be worth considering. Loans insured by the Federal Housing Administration (FHA) are easier to qualify for than other loan programs, but they require more expensive mortgage insurance premiums. Understanding how an FHA cash-out refinance works and the costs involved will help you decide if it’s the best option to access extra funds.

What is an FHA cash-out refinance?

An FHA cash-out refinance is an FHA loan option that allows you to borrow more than you currently owe and pocket the difference between the two loans in cash. You can use the money in a variety of ways, including:

• • Funding home improvements
  • Consolidating high-interest-rate debt
  • Covering higher education expenses
  • Starting a business or side hustle

How does an FHA cash-out loan work?

The process for an FHA cash-out refinance is similar to other cash-out refinance loans:

1. Shop around for the best rate with FHA-approved lenders.
2. Provide proof of your income for the past two years and have your credit report and scores pulled.
3. Lock in your interest rate (it’s not guaranteed until it’s locked in).
4. Have your home appraised. (One caveat: FHA appraisals are more expensive with more stringent property requirements than conventional appraisals.)
5. Finalize your loan figures on your closing disclosure and provide any final documents.
6. Sign your paperwork and get your cash.

FHA cash-out refinance requirements

To qualify for an FHA cash-out refinance, you need to meet the following requirements.

Occupancy and length of residence

The FHA only allows you to tap equity on a home you live in. You’ll need to prove you’ve lived in the home for 12 months or longer to be eligible for an FHA cash-out refinance.

Payment history

You must have made on-time mortgage payments the past 12 months; payments must have been made within the month due. If you own your home free and clear, you may qualify for a cash-out transaction before the 12-month period.

LTV ratio maximum

You can’t borrow more than 80% of your home’s value. Homeowners are required to have a maximum 80% loan-to-value (LTV) ratio. An LTV ratio is the percentage of your home’s value that is financed by the mortgage.

Credit score minimum

Your minimum credit score must be at least 500, which is much lower than the 620 typically required for a conventional cash-out refinance. The catch: With a lower score, you’ll have a higher interest rate and pay for FHA mortgage insurance (mortgage insurance isn’t required on conventional loans if you have at least 20% equity).

Federal debt payment history

You can’t have any unpaid federal debt. FHA-approved lenders are required to use the CAIVRS database to verify you don’t have any defaulted debt (like student loans or federal judgments) in your credit history.

Debt-to-income ratio

Your debt-to-income ratio — the percentage of your gross monthly income used to repay debt (including your mortgage) — shouldn’t exceed 50%, but a higher DTI may be approved if you have high credit scores and proof of extra mortgage reserves.

FHA loan limits

You won’t have quite as much borrowing power as conventional loans due to FHA loan limit restrictions. The 2023 FHA loan limit for single-family homes in most parts of the country is $472,030 — use the FHA’s loan limit search tool to find the limit in your area.

FHA mortgage insurance

To protect FHA-approved lenders from the risk that you might default on your loan, you’ll have to pay two types of FHA mortgage insurance. The first is an upfront mortgage insurance premium (UFMIP) of 1.75% of your loan amount, which lenders typically add to your mortgage balance at closing. You’ll also pay an ongoing mortgage insurance premium (MIP) ranging from 0.15% to 0.75%, depending on your loan term and down payment. MIP is charged annually, divided by 12 and added to your monthly mortgage payment.

Good news in 2023: Lower annual MIP premiums

The U.S. Department of Housing and Urban Development (HUD) announced a reduction in annual MIP costs. The change took effect March 20 and the average qualified borrower will save $800 yearly.

How much money can you get from an FHA cash-out refinance?

You can borrow up to 80% of your home’s value with an FHA cash-out refinance. Here’s an example, assuming your current home is worth $350,000 and you owe $250,000 on your existing mortgage:

• • $350,000 x 80% = $280,000 maximum FHA cash-out loan amount
  • $280,000 – $250,000 current loan balance = $30,000 cash back to you

FHA cash-out refinance rates: What you should know

You’ll find that FHA cash-out refinance rates are significantly lower than conventional refinance rates, but there’s a catch: FHA mortgage insurance premiums may make FHA loans more expensive than conventional loans in the long run. There’s two reasons for this:

1. You’ll pay FHA mortgage insurance even if you have 20% equity in your home, and will have to pay it for at least 11 years unless you refinance to a different loan type. You can get rid of conventional private mortgage insurance (PMI) once you can prove you have 20% equity.
2. FHA mortgage insurance is included in the APR calculation, which is a measure of the total costs of your loan over the life of the loan. Because you pay two types of premiums with FHA mortgage insurance the APR is often higher than a comparable conventional loan.

The bottom line: The long term cost of paying FHA mortgage insurance may offset the lower FHA interest rate. This might be the case when compared to a conventional loan with at least 20% equity and therefore doesn’t require any mortgage insurance. The best way to determine if you’re getting a better deal on an FHA cash-out refinance versus a conventional cash-out refinance is to compare the annual percentage rate (APR) on each option. The lower the APR, the less you’re paying in total costs.

How much are FHA cash-out refinance closing costs?

You’ll typically spend between 2% and 6% of your loan amount on FHA cash-out refinance closing costs. The standard fees such as origination, credit report and underwriting are similar to other standard loan types.

Don’t forget: You’ll pay the upfront FHA mortgage insurance fee of 1.75% and the annual MIP regardless of how much home equity you’ve built up in your home.

Pros and cons of an FHA cash-out mortgage

FHA cash-out refinance alternatives

CONVENTIONAL CASH-OUT REFINANCE.

With a 620 credit score and DTI ratio below 50%, you might benefit from a conventional cash-out refinance. Don’t forget: You won’t need mortgage insurance if you borrow 80% or less of your home’s value.

Conventional cash-out refinance rates may be higher in 2023

After May 1, 2023, Fannie Mae and Freddie Mac are charging fees between 0.375% to 5.125% of a conventional loan amount. Lenders will likely pass these fees onto consumers in the form of higher interest rates. You may want to consider an FHA cash-out refinance if you have a low credit score, since the changes don’t apply to government-backed loans.

VA CASH-OUT REFINANCE

If your military service makes you eligible for a loan backed by the U.S. Department of Veterans Affairs (VA), you can borrow up to 90% of your home’s value with a VA cash-out refinance.

HOME EQUITY LOAN

A home equity loan allows you to take out a second mortgage in a lump sum with fixed monthly payments. You can keep your current mortgage loan, but you’ll have two house payments each month.

HELOC

A home equity line of credit (HELOC) is a revolving credit line secured by your home. It works like a credit card: You only repay the portion of the credit line you borrow, plus interest. You can access and reuse the credit line during a set period, usually 10 years. After that, the remaining balance is repaid in equal installments.

FIXER-UPPER LOAN

If the sole purpose of your refinance is to make home improvements or renovations, consider a Fannie Mae HomeStyle® Renovation loan or an FHA 203(k) rehabilitation loan. You may be able to borrow more than a regular cash-out refinance, since the lender uses the “after-improved” value to determine your loan amount.

REVERSE MORTGAGE

If you’re at least 62 years old, you may be able to tap equity without making a mortgage payment through a reverse mortgage. You’ll need at least 50% equity in your home.

PERSONAL LOAN

With higher interest rates than most mortgage loans, a personal loan can be a more expensive way to borrow money. However, if you don’t want to put your home at risk of foreclosure if you default, it may be a safer option than the others mentioned above.