Your home is your most valuable asset, and if you’ve paid off a significant chunk of your mortgage, it can also help you borrow more money for major expenses such as paying for college or renovating your kitchen. One way to leverage the equity in your home is with an FHA cash-out refinance.
What is an FHA cash-out refinance?
An FHA cash-out refinance involves paying off your existing mortgage with a new, bigger mortgage insured by the Federal Housing Administration (FHA). The amount of the bigger loan is based on your level of equity, what you still owe on your current loan and how much in extra funds you need. Ideally, the new mortgage would also come with a lower interest rate.
How an FHA cash-out refinance works
Let’s say you currently owe $200,000 on your existing mortgage, and an appraisal shows your home is worth $400,000.
With an FHA cash-out refinance, you’d be able to borrow up to $320,000 — 80 percent of your property’s value. In this case, $200,000 of that would go toward paying off your existing mortgage.
However, you don’t have to borrow the full $320,000. Let’s say you just need $100,000 to finish a major home renovation. You’d go through a new mortgage application process — similar to the work you did for your first mortgage — for a $300,000 mortgage instead. Once approved, $200,000 of that will be used to pay off your old mortgage, and you’ll begin making monthly payments on your new $300,000 loan.
There are closing costs to consider (more on that below), so you’d need to factor those in if you’re planning to roll those expenses into the new mortgage, as well. There might also be the need to establish a new escrow account.
FHA cash-out refinance requirements
The FHA has minimum requirements for FHA loans, including refinances, but FHA lenders can also set their own standards in addition to those.
- Credit score: While FHA loans often make headlines for allowing credit scores as low as 500, the reality is you’ll need a higher credit score to obtain the best deal on an FHA cash-out refinance. Some lenders will approve a credit score as low as 620, but the lowest rates will go to borrowers with credit scores of 740 or higher. If you’re hoping to do a cash-out refinance, work to improve your credit well ahead of applying.
- Debt-to-income (DTI) ratio: In most cases, your DTI ratio can’t exceed 43 percent. If you have other loans or debt, it’s wise to try to pay things down before you apply for a refinance.
- Loan-to-value (LTV) ratio: …….