FHA cash-out refinances: Rules and requirements

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In a Nutshell

The Federal Housing Administration allows borrowers to take equity from their homes using an FHA cash-out refinance. But to qualify, you’ll have to meet certain standards set by the agency.
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Whether you’re renovating your home, consolidating debt or paying for education, an FHA cash-out refinance could help you access the funds you need.

The Federal Housing Administration loans are typically easier to qualify for than conventional loans because they’re federally insured. FHA loan options include a cash-out refinance, which allows borrowers to take equity from their homes.

We’ll review how FHA cash-out refinance loans work and what the qualification standards are.

What is an FHA cash-out refinance?

A cash-out refinance works similarly to any other refinance loan, where you’re replacing your current mortgage with a new one. But in the case of a cash-out refinance, your new loan is larger than your original loan and you receive the excess in cash.

Cash-out refinances allow you to take out some of the equity you’ve built up in your home.

Cash-out refinances can be used for a variety of purposes, from paying off debt to remodeling your home or sending a child to college. These loans reduce the amount of equity you have in your home but give you access to money at an interest rate that’s typically lower than you may find with a personal or home equity loan.

An FHA cash-out refinance is one of several loan programs offered by the Federal Housing Administration. Like other FHA loans, the cash-out refinances aren’t actually underwritten or lent by the FHA. Instead, they come from private lenders and are insured by the FHA, meaning if you fail to make your FHA loan payments, the agency will cover the lender’s losses.

FHA refinance requirements

Borrowers have to meet certain credit and debt-to-income ratio requirements for an FHA cash-out refinance. Expressed as a percentage, your debt-to-income, or DTI, ratio is all your monthly debt payments divided by your gross monthly income. 

When you apply for a mortgage, there are two DTI ratios that lenders may consider. The front-end DTI ratio is the percentage of pretax income going to your housing payment. The back-end DTI ratio is your total DTI ratio and includes your housing payment and all other debt.

If you have credit scores on the low end of the FHA’s home loan requirements, you’ll need a front-end DTI ratio of no more than 31% and a back-end DTI ratio of no more than 43%. If your credit scores exceed 580 and you meet certain requirements, you may have a front-end DTI ratio as high as 37% and a back-end DTI ratio as high as 47%.

The compensating factors you can use to qualify for this higher DTI ratio include …

  • Documented cash reserves
  • A minimal increase in your housing payment
  • Residual income

In some cases, you may be subject to different DTI ratio requirements. For example, if you have no qualifying debt, you can have front-end and back-end DTI ratios of up to 40%. And if you meet any of the compensating factors above and have significant income that isn’t reflected in your DTI ratio, you could qualify for a front-end DTI ratio of up to 40% and a back-end DTI ratio of up to 50%.

It’s also important to note that FHA cash-out finances are only allowed on your principal residence. You must have owned and lived in the property for at least one year before applying for your cash-out refinance. You also must be current on all your mortgage payments for at least the past year.

Minimum credit scores for an FHA cash-out refinance

One of the most attractive features of FHA cash-out refinances — and FHA loans in general — is their relaxed credit score requirements. The credit scores needed for an FHA loan are considerably lower than for a conventional loan.

The minimum credit score needed for an FHA loan is 500. Keep in mind that lenders can set their own credit requirements.

4 things to know about an FHA cash-out refinance

There are a few other things you should know before you consider an FHA cash-out refinance.

1. Types of loans eligible

Your current mortgage doesn’t have to be an FHA loan in order to qualify for an FHA cash-out refinance. You may decide to switch to an FHA loan if you want to refinance your home and if your credit scores or another factor prevents you from doing a conventional cash-out refinance.

2. Mortgage insurance

As with other FHA loans, FHA cash-out refinance loans will require that you pay an upfront mortgage insurance premium that’s equal to 1.75% of the loan amount.

FHA loans, including cash-out refinances, also require that you pay annual mortgage insurance premiums. The amount you’ll pay depends on your base loan amount and your loan-to-value ratio. These premiums range from 0.80% to 1.05% of the base loan amount per year for mortgages with terms of more than 15 years.

3. Maximum LTV

When you borrow using an FHA cash-out refinance, you are limited to how much equity you can pull from the home. The maximum loan-to-value ratio on cash-out refinances is 80% of the adjusted value of the home, which will need to be appraised as part of the loan process.

For example, suppose an appraisal shows your home is worth $300,000. The most you’d be able to borrow is $240,000, which is 80% of the home’s value. If you already have a mortgage of $210,000, you can take out no more than $30,000 in cash.

Additionally, regardless of your LTV, you can only borrow up to the FHA’s loan limits. In 2022, those limits range from $420,680 to $970,800, depending on your area’s cost of living.

4. Energy Efficient Mortgage program

FHA loans, including cash-out refinances, are eligible for the agency’s Energy Efficient Mortgage program, which allows borrowers to save on their utility bills by financing energy improvements to the home.

The amount you can finance under the EEM program isn’t included in their maximum loan amount. The EEM financing amount is added afterward. Borrowers who are a part of the EEM program may also have access to higher DTI ratios.

What’s next?

A cash-out refinance can provide you with the money you need for home improvements, debt consolidation or other financial needs. They typically have more relaxed requirements than traditional refinance loans, making them an attractive option for a lot of borrowers.

That being said, FHA loans can come with some downsides, including mortgage insurance premiums.

If you’re shopping for a cash-out refinance, it’s worth comparing the total cost of an FHA cash-out refinance to a conventional one — including interest rates and mortgage insurance — to see which makes the most sense for your situation.

About the author: Erin Gobler is a freelance personal finance writer based in Madison, Wisconsin. Erin studied journalism and political science at the University of Wisconsin-Oshkosh and began writing full-time after a seven-year caree… Read more.