How Does a FHA Cash Out Program Work

Speak to a reputable lender about cash-out refinance, and he or she will tell you this: Cash-out refinance loans are loans in excess of your previously outstanding loan amount.

That’s the easy way of explaining it. You owe a certain amount on your mortgage principal, you cash out some equity in your home, and you add the two numbers together to get your new mortgage amount.

What’s not clear, at least until you get into the nitty-gritty of the loan details, is if you even qualify or how the loan will be structured. That’s because if you have an FHA mortgage, you’ll need to meet certain requirements to access your home equity.

The First Thing To Know About FHA Cash-Out Refinance

The FHA touts itself as the largest mortgage insurer in the world, serving more than a million homebuyers each year. Other products support renters, with a focus on helping seniors and people with disabilities.

But when you dig deep into FHA refinance loan programs, you’ll discover there are two primary options: a straight FHA cash-out refinance, and an FHA streamline refinance. The FHA cash-out loan gives you exactly what’s described above — cash at closing to you, the borrower, and a bigger balance on what you now owe on your home.

But because it’s considered a riskier offer by lenders, an FHA cash-out refinance also requires additional documentation and for borrowers to meet certain eligibility requirements.

What Are the Benefits of an FHA Cash-Out Refinance?

What are the benefits of any cash-out refinance? To tap into home equity for a specific reason. Many homeowners use the cash out for home improvements, which is a smart strategy that increases your home’s value. Others use it to pay down existing debt from school loans or credit cards. Some people use it to meet other financial goals.

In any case, the FHA Cash-Out Refinance is plush with benefits. According to The Mortgage Reports, an FHA cash-out loan can be yours even if you’re a low-credit borrower. It can be yours even if you couldn’t get a home equity loan or conventional cash-out loan.

The biggest benefit, above all, is knowing that an FHA cash-out refinance will allow you to take out a loan worth up to 80% of your home’s current value. 

What You Really Need to Know About FHA Cash-Out Refi

There are pros and cons to any cash-out refinance, including a few key things you need to know about how the FHA cash-out program really works.

First and foremost, understand that the Department of Housing and Urban Development (HUD) took a huge step in 2019 to curb the number of cash-out refinances. They did this, according to the Housing Wire, by limiting cash-out refinances to 80% of a property’s value. This is down from the previous standard of 85%.

If you’re trying to picture the impact the change had, let’s do a little math on a property estimated to be worth $200,000:

With the old 85% LTV rule:

  • Property value: $200,000
  • Current loan balance: $100,000
  • 85% LTV loan: $170,000
  • Estimated closing costs: $4,000
  • Cash out: $66,000

With The New 80% LTV rule:

  • Property value: $200,000
  • Current loan balance: $100,000
  • 80% LTV loan: $160,000
  • Estimated closing costs: $4,000
  • Cash out: $56,000

The change, which went into effect for loans with case numbers assigned on or after September 1, 2019, puts the FHA in the same bracket as the loan-to-value rules through Fannie Mae and Freddie Mac.

Here’s What Else Goes Under the FHA Microscope

Your income, assets, and creditworthiness could all be factored into your request for an FHA cash-out. The value of your home and the payments you’ve been making on it will also be considered:

Credit: Your credit score is something you’ll carry with you through life. Lenders will ultimately decide whether to do business with you based on your past choices and money habits and if your debts are being paid on time.

According to existing FHA guidelines, there is no minimum credit score established for cash-out refinance, but lenders will have their own requirements. The minimum score needed for an FHA cash-out refinance is usually between 620 and 680.

You should realize that at least one credit score is needed for all FHA-backed borrowers. Other lenders might require three applicable scores, and use the lower one for qualification. A lot will be riding on the lending institution’s credit requirements in this case.

Income: One of HUD’s five key steps to homeownership includes watching your spending and savings. That’s because the FHA requires proof of sufficient income to qualify for a cash-out program. You’ll generally need to verify your income by providing a minimum of two recent paycheck stubs, along with your current year-to-date earnings. Additionally, you’ll be asked to show W-2 forms from the last two years and your most recently filed federal income tax returns.

Assets: While FHA lenders don’t always ask for asset verification, it’s possible you’ll need to provide bank and investment statements. You should check with your FHA lender to see if asset verification is part of the underwriting process. 

Appraisal: Any FHA-backed lender considering your application will require an appraisal on your home. The value will be used to determine the maximum cap on the loan (with the cash-out included). As mentioned above, the maximum loan amount is 80% of the property value. You may also be subject to further loan limits based on your state, county, or Metropolitan Statistical Area.

Still Thinking About an FHA Cash-Out?

Despite the stringent requirements, FHA cash-out loans are considered to be a good value to homeowners, especially those with lower credit. However, you should keep in mind that the FHA will require documentation proving you’ve made on-time payments on your home for the previous 12 months. Additionally, any mortgaged property must have a minimum of six months of payments before a refinance will be considered.

Beyond these requirements, the FHA will not refinance the property unless it will remain owner-occupied. Finally, it should be noted that you’ll be unable to add a co-borrower on the new loan unless he or she is also an occupant of the home.

While this article has covered the majority of things you’ll need to know about the FHA Cash-Out Program, remember that FHA-backed refinances are available (and intended) for existing FHA loans, as well as loans that originated from a non-FHA lender. That means you can apply for an FHA cash-out refinance while holding a conventional loan, a VA loan, or any other non-FHA mortgage.

On a final note, it’s in your best interest to shop around for the best interest rate on your FHA cash-out refinance, even if you end up using your existing financial institution.


Author: Bryan Dornan

Bryan Dornan is a financial journalist and currently serves as Chief Editor of Cash Out Refi Bryan has worked in the mortgage industry for over 20 years and has a wealth of experience in providing mortgage clients with the highest level of service in the industry. He also writes for RealtyTimes, Patch, Buzzfeed, Medium and other national publications. Find him on Twitter, Muckrack, Linkedin and ActiveRain.

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