Can You Get a HELOC With an FHA Loan?

Homeowners often leverage built-up equity for home improvements, debt consolidation, or other financial needs. Federal Housing Administration (FHA) loans are government-insured mortgages designed to make homeownership accessible, especially for first-time buyers. A Home Equity Line of Credit (HELOC) functions as a revolving line of credit secured by the borrower’s home equity. While both financial tools relate to homeownership and equity, directly combining an FHA loan with a new HELOC is generally not straightforward due to specific regulations governing FHA-insured mortgages.

Understanding FHA Loan Requirements

FHA loans are insured by the Federal Housing Administration (FHA). This government backing protects lenders against losses, allowing them to offer lenient terms, such as lower credit score requirements and smaller down payments, often as low as 3.5% for borrowers with a credit score of 580 or higher. The primary purpose of FHA loans is to promote homeownership for a broader range of individuals, rather than to facilitate real estate investment or provide ongoing access to equity.

A fundamental characteristic of FHA loans is the owner-occupancy requirement. Borrowers must occupy the property as their primary residence for at least 12 months following the loan’s closing. The FHA also maintains strict regulations regarding additional liens or subordinate mortgages placed on properties with an active FHA loan.

A Home Equity Line of Credit (HELOC) functions as a second mortgage, creating a junior lien on the property. FHA guidelines prioritize the first lien position of their insured mortgages and impose specific rules on other financing secured by the home. While FHA guidelines address subordinate financing in certain contexts, such as an existing second mortgage remaining in place during a refinance, they do not permit a new HELOC to be added directly to an FHA-insured first mortgage.

Refinancing Your FHA Loan to Access Equity

Since directly obtaining a HELOC with an active FHA loan is not feasible, homeowners looking to access their equity have two primary refinancing pathways. These options involve replacing the existing FHA loan with a new mortgage structure that allows for equity access.

One pathway involves refinancing the FHA loan into a conventional mortgage, and then subsequently applying for a HELOC. First, the FHA-insured loan is paid off and replaced with a new conventional mortgage, which adheres to different underwriting standards. Once the property is secured by a conventional loan, the homeowner can then apply for a HELOC as a second lien. Conventional lenders are more flexible regarding junior liens, allowing homeowners to tap into their equity through a revolving credit line.

The second common option is a cash-out refinance, which can be done with either a new FHA loan or a conventional loan. A cash-out refinance involves obtaining a new, larger mortgage that pays off the existing loan and provides the homeowner with the difference in cash at closing. For an FHA cash-out refinance, the maximum loan-to-value (LTV) ratio is 80% of the home’s appraised value. Conventional cash-out refinances also limit the LTV to 80%, though some programs may allow slightly higher. Unlike a HELOC, which offers a revolving line of credit, a cash-out refinance provides a lump sum of money, which may be more suitable for large, one-time expenses.

Key Factors Before Refinancing

Before pursuing any refinancing option to access home equity, homeowners should carefully evaluate several financial factors. Understanding these elements is essential for determining eligibility, potential costs, and the overall benefit of a refinance.

The amount of home equity accumulated is a primary consideration. Home equity is calculated by subtracting the outstanding mortgage balance from the home’s current appraised value. Lenders use this equity to determine the loan-to-value (LTV) ratio, which is the loan amount divided by the property’s appraised value. A lower LTV, indicating more equity, translates to better loan terms and more favorable eligibility. For instance, to avoid private mortgage insurance (PMI) on a conventional loan, an LTV of 80% or less is required.

Credit score plays a significant role in loan approval and the interest rates offered. Higher credit scores, generally 740 or above, qualify borrowers for the most competitive interest rates and terms on conventional loans and HELOCs. While FHA loans are known for flexible credit requirements, usually accepting scores as low as 500 or 580 with a 3.5% down payment, refinancing to a conventional loan will necessitate a minimum credit score around 620.

Another important metric is the debt-to-income (DTI) ratio, which compares monthly debt payments to gross monthly income. Lenders use DTI to assess a borrower’s capacity to manage additional debt. Lenders often prefer a DTI ratio of 36% or below, though some programs, including FHA, may approve DTI ratios up to 43% or even 50% with compensating factors.

Refinancing involves various closing costs, which are fees and expenses paid at the loan’s completion. These costs range from 2% to 5% of the total loan amount and can include appraisal fees, title insurance, and loan origination fees. Understanding these upfront expenses is important, as they can reduce the net amount of cash received in a cash-out refinance or add to the overall cost of a HELOC. Interest rates, whether fixed or adjustable, also heavily influence the long-term cost of the new loan. Cash-out refinances come with fixed rates, providing predictable monthly payments, while HELOCs feature variable rates that can fluctuate with market conditions.