What You Need To Know About An FHA Cash-Out Refinance

Is your kitchen crying out for a significant makeover? Is your expanding family in need of an additional bathroom? Are you also seeking to reduce the monthly interest rate on your mortgage loan? An FHA cash-out refinance might be the solution, offering the possibility of a reduced interest rate along with some additional funds for home improvements – or any other expenses you wish to cover.

Cash-Out Refinance Explained

A cash-out refinance enables homeowners to refinance their mortgage and receive a lump sum of cash. This is done by refinancing into a loan that exceeds the current mortgage balance.

Cash-Out Refinance: How Does It Work?

If you have $250,000 left on your mortgage, consider refinancing to a new $300,000 loan. After paying $6,500 in closing costs, you could receive a lump sum of $43,500. This amount represents the difference between your outstanding $250,000 balance and the new $300,000 mortgage, minus the closing costs.

The funds can be used for various purposes, such as creating a luxurious master bedroom, settling high-interest credit card debts, or financing your child’s college education.

See What You Qualify For

FHA Cash-Out Refinance Versus Traditional Cash-Out Refinance

In a traditional cash-out refinance, your new mortgage isn’t insured, unlike in an FHA cash-out refinance where the Federal Housing Administration (FHA) provides insurance. FHA mortgages offer approval possibilities for homeowners with lower credit scores and feature lower interest rates. 

However, a drawback is the requirement to pay mortgage insurance premiums (MIP) for either 11 years or the mortgage’s lifespan, depending on the borrowed amount and mortgage terms. Evaluating whether the benefits of an FHA cash-out refinance outweigh the drawbacks is crucial.

Is an Existing FHA Loan Required for an FHA Cash Out Refinance?

You can apply for an FHA cash-out refinance even if you don’t have an existing FHA loan. Whether you’re currently paying off a conventional mortgage or own your home outright, accessing your equity is possible. If you have an FHA loan, consider an FHA Streamline refinance for a simpler process, though cash-out limits apply.

The Process of FHA Cash-Out Refinancing

The essential steps for executing an FHA cash-out refinance mirror those needed for a traditional mortgage refinance.

Assess Your Available Equity

To be eligible, you must possess sufficient home equity, a strong credit score, and a consistent monthly income that can easily manage all your debts, including the new mortgage payment.

Locate a Lender for an FHA Mortgage.

When you’re prepared for refinancing, your initial step is to apply with a mortgage lender that provides FHA loans. Luckily, almost all mortgage lenders offer this. FHA solely insures mortgages and does not originate them, hence the necessity of a private mortgage lender like a bank, credit union, or another financial institution.

Submit an Application

To initiate the process, complete a Uniform Residential Loan Application with details like your full name, current address, and Social Security number. Additionally, disclose your monthly income and existing debts.

Your lender will review your credit reports – one from each national credit bureau, Experian™, Equifax®, and TransUnion® – as well as your FICO® Score. They will request supporting documentation tailored to your needs. An appraisal will be ordered to confirm your property’s value.

Closing Day

Upon approval, you’ll sign closing papers and cover any associated costs, which may potentially be financed into your loan. Your current mortgage will be swapped with a new FHA loan, with a lump sum payment typically provided as a check from the cash-out portion of the refinance. However, you won’t receive this immediately on closing day; there’s a 3-day window for you to reconsider the refinance process for a primary residence.

Requirements for FHA Cash-Out Refinance

To be eligible for an FHA cash-out refinance, specific requirements must be met.

Credit Score

To qualify for an FHA-insured mortgage, the FHA mandates a minimum credit score of 500. Nevertheless, individual private lenders typically establish their own credit score prerequisites. Rocket Mortgage® specifies a minimum median score of 580 for an FHA loan. Adhering to these mortgage refinance criteria is crucial as you’ll need to engage with one of these lenders to finalize an FHA loan.

The median FICO® Score required to be eligible for an FHA cash-out refinance hinges on the purpose and whether you are an existing client. If your intention is to settle debts at closing, a credit score as low as 580 qualifies for a debt consolidation. For all other cash-out refinance purposes, a median FICO® Score of 620 or higher is necessary.

A higher credit score translates to a lower interest rate, essential for reaping monthly savings with an FHA cash-out refinance. Optimal interest rates are attainable with a credit score of 760 or above.

Having a credit score of 620 or higher also allows for qualification with a slightly elevated debt-to-income ratio (DTI).

Loan-To-Value (LTV)

Your loan-to-value ratio, often referred to as LTV, plays a crucial role. It gauges the equity in your home by comparing your outstanding mortgage balance to the current value of your home. For instance, if your home is valued at $200,000 and your mortgage balance stands at $120,000, you hold $80,000 in equity, resulting in an LTV of 60%.

To be eligible for an FHA cash-out refinance, you can leverage up to 80% of your home’s LTV provided you’ve owned the property for a year or more and are seeking a loan of $417,000 or less. In the scenario outlined above, you could secure an FHA cash-out mortgage of $160,000.

However, if you owe $190,000 on your mortgage while your home is valued at $200,000, you would not meet the criteria for an FHA cash-out refinance due to your LTV.

Length Of Residence

To be eligible for an FHA cash-out refinance on your home with the mortgage you’re refinancing, a minimum residency of 12 months is required. Should you have resided in the property for just 10 months, you will need to wait an additional two months before applying for the FHA cash-out refinance. Limited exceptions apply, including scenarios involving inherited properties.

Payment History

The FHA mandates a clean record of no late mortgage payments in the last 12 months for cash-out refinancing. If you’ve consistently paid your mortgage on time for a year, you meet the criteria for this refinancing option.

Even if you’ve held the title for just a year but have had the mortgage for a short duration, you could still qualify for cash-out refinancing by demonstrating at least 6 months of timely payments.

What Amount of Cash is Available Through an FHA Cash-Out Refinance?

The cash amount available through a cash-out refinance is determined by the equity in your home. It’s important to note that you can borrow a maximum of 80% of your home’s Loan-to-Value (LTV) ratio. 

To get an idea of the cash you could receive from such refinancing, simply follow these steps..

Discover the Present Appraised Value of Your Home

To accurately ascertain your home’s current value, hiring a professional appraiser is crucial. If you’re looking for an estimate, platforms like Rocket Homes℠ can provide insights. When discussing with a lender, inquire about the method they will use to appraise your home.

Calculate the Equity Value in Your Home

Calculate your home’s value first, then deduct 20% to determine the required home equity. This figure provides an approximate amount obtainable through an FHA cash-out refinance.

Deduct the remaining balance you owe.

If you still have a mortgage on your home, subtract the current balance from the available equity. The remaining amount is what you can borrow through an FHA cash-out refinance.

Example:

Your home’s estimated value is $200,000, offering potential equity of 95%, which amounts to $190,000. With a remaining mortgage loan of $150,000, you could potentially cash out up to $40,000. Remember, these are approximations and should be confirmed by consulting a mortgage lender and engaging an appraiser for an accurate valuation of your home and precise details on refinance closing costs.

Explore Supplementary Expenses

When securing a mortgage, it’s important to budget for closing costs payable to your lender. These costs typically vary from a few hundred dollars to up to 3% of the loan amount. Additionally, opting for an FHA loan means you’ll need to cover mortgage insurance premiums (MIP), which are categorized into two types:

• Upfront MIP: Upon loan origination, an upfront Mortgage Insurance Premium (MIP) of 1.5% is due, equating to $2,400 for a $160,000 loan. This can be paid upfront or included in your monthly mortgage payment.
• Annual MIP: An annual Mortgage Insurance Payment (MIP) of 0.5% of the loan amount is also required, amounting to $800 per year or $66.67 per month for a $160,000 loan. These payments must be made for either 11 years or the duration of the mortgage, depending on the loan terms.

The Advantages and Disadvantages of Utilizing the FHA Cash-Out Refinance Option

Like all mortgage options, an FHA cash-out refinance comes with its own set of advantages and disadvantages.

Advantages

• Flexibility at its finest: With an FHA cash-out refinance, the funds are yours to use as you please. Whether it’s home renovations or clearing credit card debt, the choice is all yours.
• Reduced credit prerequisites: FHA’s credit score criteria are less stringent compared to those of a non-government-insured conventional loan. However, note that if your credit score is too low, securing a lender might still pose challenges, even if your score technically meets the FHA’s criteria.
• Lower interest rates: Similar to many mortgages, FHA loans typically offer lower interest rates compared to credit cards or personal loans. Utilizing a cash-out refinance becomes an efficient method to borrow at a reduced cost or settle high-interest debt at a more advantageous rate.

Disadvantages

• Elevated monthly payments: Depending on the new interest rate, refinanced amount, and terms, your monthly mortgage payments could increase. Factor this into your monthly budget planning.
• Taking on more debt: When opting for an FHA cash-out refinance, you borrow beyond your current debt. For instance, if you owe $150,000 and refinance for $180,000, you increase your debt by $30,000.
• Mortgage insurance: FHA loans mandate two types of mortgage insurance, which you must pay for. Initially, there’s an upfront mortgage insurance fee of 1.75% of the new loan amount, say $3,500 for a $200,000 loan. This can be paid upfront or rolled into your monthly payment. Additionally, you’ll have to cover an annual mortgage insurance payment of 0.80% of the loan amount, like $1,600 per year for a $200,000 loan, spread out monthly for 11 years.

Deciding on an FHA Cash-Out Refinance: Is It the Right Choice for You?

If you require a substantial sum of money for a specific purpose, opting for an FHA cash-out refinance can be a cost-effective solution, especially in times of low interest rates. Deciding whether to pursue an FHA cash-out refinance depends on your financial needs, current mortgage balance, and property value.

Ready to explore refinancing options? You can conveniently apply online for an FHA cash-out refinance today or reach out to us at 719.247.6622.