How Does FHA Cash-Out Refinance Work?

Your home is likely your most valuable asset, and if you’ve paid down a substantial portion of your mortgage, it can be a powerful tool for accessing funds for major expenses, like college tuition or a kitchen renovation. One way to tap into this equity is through an FHA cash-out refinance.

What is an FHA cash-out refinance?

An FHA cash-out refinance entails replacing your current mortgage with a new, larger loan insured by the Federal Housing Administration (FHA). This new loan amount is determined by your home’s equity, the balance remaining on your existing mortgage, and the additional funds you need. Ideally, the new mortgage should also offer a lower interest rate.

How an FHA cash-out refinance works

The amount you can borrow through an FHA cash-out refinance largely depends on your home’s current value.

For example, if you owe $200,000 on your existing mortgage and your home is appraised at $400,000, you could potentially borrow up to $320,000—80 percent of your home’s value. Of this amount, $200,000 would be used to pay off your existing mortgage.

However, you don’t have to take the full $320,000. If you only need $100,000 for a major home renovation, you could apply for a new $300,000 mortgage. After approval, $200,000 would go towards settling your old mortgage, and you’d start making payments on the new $300,000 loan.

Keep in mind that closing costs, typically around 4 percent of the loan amount, should also be considered. If you plan to include these costs in your new mortgage, you’ll need to factor them into your total loan amount. Additionally, you might need to set up a new escrow account as part of the refinancing process.

FHA cash-out refinance requirements

The FHA sets minimum requirements for FHA loans, including cash-out refinances, but individual lenders may have additional criteria.

• Credit Score: Although FHA loans are known for accommodating lower credit scores, such as 500, securing the best terms for an FHA cash-out refinance typically requires a higher score. While some lenders may approve scores as low as 620, the most favorable rates are usually reserved for those with scores of 740 or above. It’s advisable to work on improving your credit before applying for a cash-out refinance.
• Debt-to-Income (DTI) Ratio: Your DTI ratio generally should not exceed 43 percent. If you have existing loans or other debt, consider reducing them before applying for a refinance to improve your chances.
• Loan-to-Value (LTV) Ratio: You must have at least 20 percent equity in your property after the cash-out refinance.
• Loan Limits: There are caps on how much you can borrow, which vary by location. For 2024, the standard limit for a single-family home is $498,257, but in some high-cost areas, the limit can go up to $1,149,835.
• Mortgage Insurance: All FHA loans, including cash-out refinances, require mortgage insurance. You’ll pay an upfront premium of 1.75 percent of the loan amount, followed by an annual premium between 0.45 percent and 0.80 percent, depending on the length of your mortgage. While most FHA loans require mortgage insurance for the entire term, it can be removed after 11 years if you make a down payment of at least 10 percent.
• Occupancy and Property Requirements: The property must be your primary residence, and you need to have lived in it for at least the past 12 months. If you’ve only recently moved in, you’ll need to wait before considering a cash-out refinance.
• Payment Standing: You must be current on your existing mortgage, having made at least the past 12 monthly payments on time.

How much does an FHA cash-out refinance cost?

An FHA cash-out refinance comes with costs beyond the new loan amount. You’ll need to cover closing costs, which typically range from 2 percent to 6 percent of the loan value. For a $250,000 loan, this means closing costs could be between $5,000 and $15,000.

These costs include an upfront FHA mortgage insurance premium (MIP) of 1.75 percent of the loan amount, which, in this case, would be $4,375. Additionally, you’ll need to account for other fees, such as lender charges, appraisal fees, and title search costs.

Pros and cons of an FHA cash-out refinance

FHA cash-out refinance loans offer several benefits for homeowners seeking to access their home equity, but it’s essential to weigh the potential drawbacks before applying.

Pros of an FHA cash-out refinance

• Flexible Eligibility: You don’t need perfect credit to qualify. While a lower credit score may result in a higher interest rate, the flexibility can still make it accessible.
• Not Limited to FHA Loans: You can use an FHA cash-out refinance with any existing mortgage, not just FHA loans.
• Assumable Loans: If you decide to sell your home, a buyer who meets FHA credit requirements can assume your loan. “If interest rates rise significantly, having an assumable loan can make your property more attractive and easier to sell,” says Todd Johnson, senior vice president and capital markets portfolio management director for Wells Fargo.

Cons of an FHA cash-out refinance

• Increased Debt Load: A higher mortgage balance will likely lead to larger monthly payments.
• Additional Costs: Besides the loan amount, you’ll need to cover costs such as MIP, appraisal fees, and title services.
• Primary Residence Requirement: FHA cash-out refinances are only available for the home you live in; they cannot be used for rental or second homes.

FHA cash-out refinance vs. other loan types

While FHA cash-out refinances offer flexible eligibility guidelines and can be a great option for some homeowners, they aren’t the only choice available. Depending on your needs and financial situation, you might also consider a conventional cash-out refinance or an FHA streamline refinance.

FHA cash-out vs. conventional cash-out refinance

Both FHA and conventional cash-out refinances aim to help you access additional funds, but there are key differences to consider. If you have strong credit, a conventional refinance might be a better option to avoid paying mortgage insurance premiums (MIP), which are required with FHA loans.

According to Johnson, conventional loans with an 80 percent LTV ratio typically don’t require private mortgage insurance, unlike FHA loans. However, this doesn’t always make conventional loans cheaper. “It’s crucial to discuss your options with lenders to make an informed decision based on your individual circumstances,” Johnson notes. Consulting with your accountant or financial advisor can also help you understand how refinancing might affect your savings and overall financial plan.

FHA cash-out vs. FHA streamline refinance

If you don’t need extra cash, an FHA streamline refinance could be a simpler way to lower your monthly payments. As its name suggests, the process is streamlined, requiring less paperwork and minimal underwriting. Some options even allow for non-credit qualifying, so you might be approved without a detailed credit review. However, keep in mind that FHA streamline refinances are only available to current FHA borrowers.