What Does “FHA Cash-Out Refinance” Mean?

Plan on making changes to your house, like adding on or remodeling the kitchen? FHA might be a good option to refinance with cash out. The FHA cash-out refinance loan lets you refinance your mortgage, usually at a lower interest rate, and take up to 80% of the equity you have in your home for home improvements or remodeling (as well as debt consolidation and other reasons). Equity is the gap between your home’s current worth and the mortgage balance.

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  • The FHA cash-out refinance loan works the same way as other cash-out refinance loans. For example, if your mortgage is $200,000, you might be able to get a new loan for $225,000. Your old loan is paid off with $200,000, and you get to keep the other $25,000.
  • FHA loans are good for people with bad credit because they have less strict rules about how much debt you can have.
  • Using the equity you’ve built up in your home, an FHA cash-out refinance, you borrow money to improve your home at today’s low-interest rates.

How much cash can you get?

With an FHA cash-out refinance, your home equity determines how much money you can get. But after you refinance and take some cash out, you must still have at least 20% of equity left. In other words, you can’t take all of the available equity.

Sites like Zillow can give you a rough estimate of how much your home is worth. Then, take the estimated value of your home and take away what you still owe on your mortgage. If you still owe $250,000 on your home, but it is now worth $450,000, you have $200,000 in equity. You could borrow $360,000, which is 80% of the value of your home. Out of that, $250,000 will be used to pay off your mortgage, leaving you with $110,000 after closing costs.

Who can get an FHA cash-out refinancing loan?

Even if your existing mortgage is not an FHA loan, you are still eligible to refinance with an FHA cash-out refinance loan.

But there are some requirements you must meet to be eligible for a loan:

  • Kind of house. FHA cash-out refinances loans can only be used for primary homes owned and lived in by the borrower. A vacation home or rental property is not eligible for this program.
  • Spending time at home. You must have owned and lived in the home for at least a year.
  • History of payments. During the past year, all mortgage payments should have been made on time.
  • Loan-to-value ratios (LTV). An FHA cash-out refinance loan can have an LTV of up to 80%.
  • This means that the amount you still owe on your mortgage can’t be more than 80% of what your home is worth. For example, you can’t use the cash-out refinance option if your home is worth $200,000 and you owe $170,000 (an LTV ratio of 85%).

Who Is Eligible for a Cash-Out FHA Refinance?

Credit Rating

FHA rules say applicants must score at least 580 to be eligible. But most lenders who offer FHA cash-out refinance loans set their limits, usually between 600 and 620, for a minimum score. If there are three scores, some lenders will choose the middle one. Others might want the lowest score to count. Your lender is the best person to ask about what credit score they need.

The ratio of Debt to Income

The FHA has rules about how much debt you can have compared to how much money you make. This is to make sure you can pay your new mortgage without getting over your head. This may be computed in several ways, but it’s the ratio of your total debt to your gross monthly income.

The ratio of your mortgage payment to your gross monthly income is found by dividing the total amount you pay for your home (principal, interest, taxes, insurance, HOA fees, etc.) by your gross monthly income. This number can’t be above 31%.

Calculating your total fixed payment to income involves summing up all of your monthly recurring costs, including student loans, credit card debt, vehicle loans, and your entire mortgage payment (principal, interest, taxes, insurance, HOA fees, etc.). Take your monthly income and divide it by that number. This is your debt ratio, which should be less than 43%.

Loan to Value Limit

LTV, which stands for loan-to-value, is the equity you have in your home. So, if you owe $315,000 on your mortgage but your home is worth $500,000, your LTV is the difference, or $185,000. For an FHA cash-out refinance, the amount you owe on your mortgage can’t be more than 80% of the value of your home. If your house is worth $500,000, 80% is $400,000 ($500,000 x 0.8). You can’t get an FHA cash-out to refinance if you owe more than $400,000.

Time Spent at Home

For the cash-out refinance loan, the FHA also has a residency requirement, according to which you must live in your dwelling and have held the mortgage you are refinancing for at least 12 months.

History of Mortgage Payment

For the FHA cash-out refinance to work, you must also have paid your mortgage on time for the past year. That means you can’t have been late with any payments in the last year.

Rates of interest

Most of the time, the interest rates on FHA cash-out refinances are low. On average, they will be 10-15 basis points (0.15-0.15%) lower than regular cash-out refinance loans. But because the FHA is more flexible than conventional loans regarding credit scores and debt-to-income ratios, the loan requires mortgage insurance with upfront and monthly loan insurance premiums (1.75 percent of the new loan amount and 0.85 percent of the loan amount every year in 12 payments).

In conclusion

Even though it has more insurance, the FHA cash-out refinance is a good product to look into if you need a cash-out to refinance a loan and have a high debt-to-income ratio or low credit scores. People with good credit and 20% equity would save more money with a conventional cash-out refinance.

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