FHA Cash-Out Refinance: A How-To Guide

Is your kitchen begging for a major renovation? Does your growing family need a second bathroom? Would you also like to lower your mortgage loan’s monthly interest rate? An FHA cash-out refinance could help, potentially giving you a lower interest rate and some extra cash for home renovations – or anything else you’d like to spend it on.

A cash-out refinance is a way for homeowners to both refinance their mortgage loan and pocket a lump sum payment of cash at the end of the process. Owners do this by refinancing into a loan that is larger than what they owe on their current mortgage.

Say you owe $150,000 on your existing mortgage. You might refinance to a new mortgage loan worth $200,000, paying $4,500 in closing costs to do so. You’d then take $45,500 in a lump sum payment, the difference between the $150,000 you owe and your new $200,000 mortgage minus your $4,500 in closing costs.

You can use that money for anything, whether you want to build a main bedroom suite, pay off high-interest-rate credit card debt or pay for a child’s college tuition.

The difference between a traditional cash-out refinance and an FHA cash-out refinance is that your new mortgage will be insured by the Federal Housing Administration. With FHA mortgages, homeowners with lower credit scores can be approved and the loans come with lower interest rates. On the negative side, you will have to pay mortgage insurance for 11 years. You’ll have to determine, then, if the positives of an FHA cash-out refinance outweigh the negatives.

In good news, though, you don’t need to be currently paying off an FHA loan to apply for an FHA cash-out refinance. Unlike an FHA Streamline refinance, which requires less paperwork, you can apply for an FHA cash-out refinance even if you are currently paying off a conventional mortgage loan, one not insured by any government agency.

The key to an FHA cash-out refinance is the same as it is for any refinance: To qualify, you’ll need enough equity in your home, a high enough credit score and a steady enough monthly income stream to comfortably cover your debts, including your new monthly mortgage payment.

When you’re ready to refinance, you’ll first apply with a mortgage lender who works with FHA loans. Fortunately, nearly all mortgage lenders do this. The FHA only insures mortgages. The agency doesn’t originate them, which is why you’ll need the services of a private mortgage lender such as a bank, credit union or other financial institution.

You’ll fill out a Uniform Residential Loan Application to start the process, providing personal information such as your full name, current address and Social Security number. You’ll also provide information on your monthly income and current debts. Your lender will check your three credit reports – one each maintained by the national credit bureaus of Experian™, Equifax^® and TransUnion^® – and check your three-digit FICO^® Score.

If you are approved, you’ll need to sign closing papers and pay any closing costs. Your existing mortgage loan would then be replaced with a new FHA loan. You’ll also receive the lump sum payment, most often in the form of a check, from the cash-out portion of the refinance. You won’t receive this right away on closing day because you have 3 days to change your mind on a refinance for a primary residence.

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

Credit Score

The FHA requires a minimum credit score of 500 for all mortgages it insures. However, most private lenders will have their own credit score requirements. Rocket Mortgage^® requires a minimum median score of 580 for an FHA loan. You’ll have to meet these mortgage refinance requirements because you’ll need to work with one of these lenders to close an FHA loan.

The median FICO^® Score needed to qualify for an FHA cash-out refinance depends on whether you're an existing client of ours and your purpose in doing so. If you're a Rocket Mortgage-serviced client using the funds to pay off debt at closing, you can do a debt consolidation with a qualifying credit score of as low as 580. All other purposes for a cash-out refinance require a median FICO^® Score of 620 or better.

The higher your credit score, the lower your interest rate will be, and you’ll need a low rate to enjoy monthly savings with an FHA cash-out refinance. You can expect the lowest interest rates with a credit score of 760 or higher.

The other advantage with a credit score of 620 or better is that you can qualify with a slightly higher debt-to-income ratio (DTI).

Loan-To-Value (LTV)

Your loan-to-value ratio, better known as your LTV, is also a key factor. This ratio measures the amount of equity you have in your home, which is the difference between what you owe on your mortgage and what your home is currently worth. If your home is worth $200,000 and you owe $150,000 on your mortgage, you have $50,000 in equity.

To qualify for an FHA cash-out refinance, the amount you owe on your mortgage can be no more than 80% of your home’s value. If you owe $180,000 on your mortgage and your home is worth $182,000, you won’t be able to qualify for an FHA cash-out refinance due to your LTV.

Length Of Residence

You must have lived in your home – the one with the mortgage you are refinancing – for at least 12 months to qualify for an FHA cash-out refinance. If you’ve only lived in the home for 10 months, you’ll have to wait two more before applying for that FHA cash-out refinance. There are limited exceptions to this, such as for inherited properties.

Payment History

The FHA also requires that you have no late mortgage payments during the last 12 months. If you’ve paid your mortgage on time for at least a year straight? You’re then eligible to apply for one of these refinances.

If you’ve been on the title for the past year, but you’ve had your mortgage for a short period of time, you may still be eligible to take cash out if you’ve had your mortgage for at least 6 months with no late payments.

The amount of cash you can take out from a cash-out refinance depends on the equity you have in your home.

To qualify for an FHA cash-out refinance, you must have 20% equity in your home. But you must also have at least 20% equity left in your home after your FHA cash-out refinance is complete, something that limits the amount of cash you can take out. This means that you won’t be able to refinance your loan into one that’s infinitely larger than what you currently owe.

If you want an estimate of how much cash you can get from one of these refinances, first estimate the total equity in your home. You can do this by subtracting the amount you owe on your mortgage loan from its estimated current appraised value. Unless you pay for a professional appraiser, you won’t be able to determine your home’s exact current value, but you can estimate what your home is worth by checking sites such as Rocket Homes^SM.

Once you have this figure, subtract 20% from it, representing the equity you need after closing your refinance, plus your estimated closing costs. This will give you a rough estimate of how much cash you can get from an FHA cash-out refinance.

Here’s an example: Say you estimate that your home is worth $200,000 and you owe $120,000 on your loan. You can take out a new FHA loan for a maximum of $160,000, which is 80% of your home's $200,000 value.

You'd use that $160,000 to pay off your current mortgage loan of $120,000, leaving you with $40,000. If you then subtract closing costs, which we can estimate at $5,000, you'd be left with $35,000 in cash.

Again, this isn’t an exact figure, but rather an estimate on your part. You’d need to speak with a mortgage lender and hire an appraiser to determine the exact value of your home and the actual closing costs involved in your refinance.

As with all mortgage products, there are both pros and cons with an FHA cash-out refinance:

Pros

• Flexibility: You can spend the money from an FHA cash-out refinance on anything you want. Want to renovate your home? You can. Want to pay off that credit card debt? You can.
• Lower credit requirements: The FHA’s credit score requirements are lower than what you’d find with a conventional loan not insured by the federal government. Remember, though, that if your credit score is too low, you might still struggle to find a lender willing to lend you money, even if your score technically falls within the FHA’s range.
• Cash at a low cost: FHA loans may come with lower interest rates. This makes borrowing money through a cash-out refinance more affordable than getting it through personal loans or running up your credit card debt.

Cons

• Increased debt: When you take out an FHA cash-out refinance, you are borrowing more than what you owe. If you owe $150,000 and take out a cash-out refinance for $180,000, you’ve boosted your debt by $30,000.
• Mortgage insurance: All FHA loans require two forms of mortgage insurance, the price of which you must cover. You'll pay for upfront mortgage insurance when you take out your loan. This comes out to 1.75% of the new loan amount. If your new loan is $200,000, your upfront mortgage insurance payment will be $3,500. You can pay that upfront or roll it into your monthly mortgage payment. You'll also pay an annual mortgage insurance payment of 0.85% of your loan amount. If your loan is $200,000, you'd pay $1,600 a year, split up in your monthly payments. This annual payment remains in place for 11 years.

If you have a specific need for a large chunk of money, borrowing through an FHA cash-out refinance could be affordable. This is especially true when current interest rates are low. Whether you should apply for an FHA cash-out refinance depends on what you need the money for, how much you owe on your current mortgage and what your home is worth.

Ready to refinance? Apply online for an FHA cash-out refinance today or give us a call at (833) 326-6018.