An FHA cash-out refinance is one way to tap into your home equity while modify the terms of your mortgage. Find out how it works.
Sure, it’s a great place to live, but owning a home has another benefit: Growing your personal wealth.
With every house payment, you own a little bit more of your home’s value. Within a few years you could own tens of thousands of dollars in home equity.*
An FHA cash-out refinance loan helps you use this equity without selling your home.
What's in this Article?
An FHA cash-out refinance is an FHA loan that is bigger than your current mortgage, yielding cash back to you at closing.
Like other FHA loans, you’ll pay an upfront and annual mortgage insurance premium and adhere to other FHA lending rules.
You may opt for an FHA cash-out loan if you have substantial equity in your home, but don’t quite have the credit score good enough to qualify for a conventional loan.
Let’s say you own a home valued at $250,000 but you owe only $150,000 on your current mortgage loan.
You could get an FHA cash-out refinance loan of $200,000 which would pay off your current $150,000 loan with $50,000 to spare. Assuming closing costs of $5,000, this remaining $45,000 becomes cash back for you.
It’s not free money. You’ll be repaying it with interest through the monthly mortgage payments on your new $200,000 home loan. The extra $50,000 would probably add more than $200 per month onto your mortgage at current rates. So it’s for you to decide whether that cash is worth it.
But because it’s secured by your home equity, you’ll probably pay a lower interest rate compared to a personal loan or a credit card.
What are the requirements?
Because you pay mortgage insurance, FHA cash-out refinance loans can sometimes be had at great rates, even when a borrower’s credit history isn’t perfect.
Still, not every borrower will qualify.
FHA cash-out refinance requirements:
- Enough home equity: This loan works only when you have enough home equity. Typically, it doesn’t make sense unless you have 25-30% equity in the home. Otherwise, it may not be worth incurring closing costs to receive a small amount of cash. But technically, you need at least 20% in home equity, since the maximum loan-to-value is 80%.
- A target credit score: The FHA allows credit scores as low as 500, but cash-out refinance lenders usually look for scores of at least 580 to 620. A higher score could lower your rate.
- A decent DTI (Debt-to-Income)**: Most FHA lenders require a debt-to-income ratio of 45% or less, though some can go a little higher.
You’ll also need to show proof of your income just like you did to get your original mortgage and a full appraisal to prove the home’s current value.
While the FHA sets guidelines for the loans it insures, lenders also have their own rules which can vary some. So, shopping around with at least three different lenders can help find your best FHA cash-out refinance rates.
Homeowners who benefit most from an FHA cash-out refi need both its benefits:
- A refinance of their existing mortgage: Getting a new loan gives you a chance to lower your interest rate compared to the rate on your existing loan. You could also change your loan term to create lower monthly payments if necessary.
- Cash back from home equity: Since the new loan exceeds your current mortgage debt, it can serve as a home equity loan.
If you don’t need both of these features, another type of loan could be a better deal for you.
For example, if you couldn’t possibly get a lower mortgage rate than you already have, but you need to borrow against your home equity, you could get a simple home equity loan.
Then you’d have two payments due each month: one for your current loan and another payment for your separate home equity loan. These are often called second mortgages.
Banks and credit unions often offer home equity lines of credit which resemble credit cards with lower rates since they’re secured by your home equity.
Rate-and-term refinance vs. FHA cash-out refi
If you don’t have enough home equity to borrow from — but you could get a lower mortgage rate or a better loan term — a rate-and-term refinance could work.
This kind of loan replaces your current loan with another one that’s about the same size — not a larger loan to generate cash back. You’re essentially only paying on what you currently owe, versus what you originally financed.
Rate-and-term refinances typically come with lower rates and simpler qualification standards than cash-out loans.
Streamline refinance vs. FHA cash-out refi
Streamline refinances are among the simplest and most affordable types of refinance loans. They often don’t require an appraisal or income documentation. But these work only for loans of the same type.
For example, you can get an FHA Streamline Refinance only if you already have an FHA loan. The same is true for VA and USDA streamline refinances.
These loans don’t offer cash back except in specific scenarios. The VA streamline loan, for example, can yield $6,000 cash back to pay for energy efficient home improvements.
If you are a veteran or current military servicemember, the VA cash-out refinances could offer a loan up to 100% of your home value.
Plus, the VA loan wouldn’t require ongoing mortgage insurance premiums like an FHA loan does.
You could also get a conventional cash-out refinance loan which isn’t insured by the federal government. These loans resemble FHA cash-out refinances except there’s:
- No mortgage insurance: Unless you borrow more than 80% of your home’s value, you don’t need to pay for private mortgage insurance on a conventional loan.
- Stricter underwriting: Since the government won’t insure your loan, you’ll need a higher credit score and a lower DTI to get a good refinance rate.
How can I use the cash back?
Money from a cash-out refinance is yours to spend as you need. You could take an extended vacation or buy a new car. The FHA won’t mind.
But remember: You will have to pay the money back as part of your new mortgage loan. This can take decades. Even at today’s low FHA cash-out refinance rates, home loans accrue a lot of long-term interest as the years pass.
So it’s usually best to spend your cash back on long-term needs such as home improvements, debt consolidation, or making another real estate investment.
The FHA allows an LTV of 80% on cash-out refinance loans. This means your maximum loan size can’t exceed 80% of your home’s value. On a $250,000 home, 80% equals $200,000.
To receive cash back in this case, you’d need to owe less than $200,000 on your current loan. Rising home values over the past couple years have helped Americans grow more home equity.
Yes, the FHA allows you to take cash-out on its refinance loans. Private lenders throughout the nation offer FHA-backed loans, including the cash-out refi option.
Yes. The FHA allows cash back on a refinance loan as long as your loan doesn’t exceed 80% of your home’s appraised value.
The FHA will allow credit scores as low as 500, but lenders have the final say. Most look for scores of 580 or higher to allow cash-out.
With rates still near historic lows and home equity rising, it could make sense to tap into your home’s equity to accomplish your financial goals.
If done wisely, getting an FHA cash-out refinance can be a smart move.
Fairway is not affiliated with any government agencies. These materials are not from VA, HUD or FHA, and were not approved by VA, HUD or FHA, or any other government agency.
*The information contained herein is distributed for educational purposes only. Fairway does not guarantee a mortgage loan will result in equity gains or tax advantages. Contact your Fairway loan officer for more information regarding your specific situation.
**Debt-to-income (DTI) ratio is monthly debt/expenses divided by gross monthly income.