What Is an FHA Cash-Out Refinance?

An FHA cash-out refinance is a mortgage refinancing option supported by the Federal Housing Administration (FHA). It allows homeowners to convert a portion of their home equity into cash without selling the property, regardless of their original mortgage type.

What is FHA Cash-Out Refinance?

An FHA cash-out refinance replaces an existing mortgage with a new, larger FHA-insured mortgage. This allows the borrower to receive a lump sum of cash at closing, converting home equity into accessible funds.

The existing mortgage does not need to be an FHA loan; homeowners with conventional or other loan types can qualify. The FHA’s insurance can make the new loan more accessible than conventional financing. The cash received is from home equity, not a separate loan.

Eligibility Criteria

Homeowners must meet specific borrower, property, and financial requirements. Lenders typically look for a minimum credit score, often around 600, although some may accept scores as low as 500. Borrowers also need to demonstrate a manageable debt-to-income (DTI) ratio, which generally should not exceed 43% of their gross monthly income. In some cases, with compensating factors, a DTI of up to 57% might be considered. Lenders will also assess employment history to ensure stability, typically requiring at least two years of consistent work.

The property itself must satisfy several criteria to be eligible for an FHA cash-out refinance. The home must serve as the borrower’s primary residence, and the homeowner must have occupied it for at least the 12 months preceding the loan application. The property must also adhere to FHA minimum property standards, which ensure the home is safe, structurally sound, and secure. An FHA-approved appraisal will be conducted to verify these property conditions and its market value.

Financial requirements also play a role in determining eligibility. Homeowners must possess sufficient equity in their property to qualify for a cash-out refinance. This generally means having more than 20% equity in the home. The existing mortgage on the property must either be paid off or refinanced as part of the new FHA cash-out loan. Additionally, borrowers must have a history of on-time mortgage payments for the past 12 months. To verify these criteria, applicants will typically need to provide documentation such as income statements, bank records, and property deeds.

Determining Your Cash-Out Amount

The amount of cash a homeowner can receive from an FHA cash-out refinance is primarily determined by the home’s appraised value and the maximum loan-to-value (LTV) ratio allowed. For FHA cash-out refinances, the maximum LTV is typically 80% of the home’s current appraised value. This means the new FHA-insured mortgage, including the cash-out portion, cannot exceed 80% of what the home is currently worth. Homeowners need to have more than 20% equity in their home to qualify for this LTV.

A clear calculation helps illustrate this: the maximum cash-out amount can be estimated by taking the home’s appraised value, multiplying it by the 80% LTV limit, and then subtracting the outstanding balance of the existing mortgage. For instance, if a home is appraised at $300,000, the maximum new loan amount would be $240,000 (80% of $300,000). If the existing mortgage balance is $180,000, the potential cash-out would be $60,000, before accounting for closing costs. The home’s current appraised value is assessed by an FHA-approved appraiser.

Furthermore, the total loan amount, including the cash-out portion, must remain within the FHA loan limits established for the specific geographic area. These limits vary by county and are updated annually to reflect local housing costs. These limits can impact the maximum amount a homeowner can borrow, especially in markets with high property values.

The Application and Funding Process

Initiating an FHA cash-out refinance involves identifying an FHA-approved lender. Once a lender is chosen, the homeowner submits an initial application, providing necessary financial and personal documentation, such as income verification and bank statements. This step allows the lender to conduct a preliminary assessment of eligibility.

Following the initial application, the process moves into underwriting, where the lender thoroughly reviews the borrower’s financial profile. This includes comprehensive credit checks and detailed income verification. As part of this stage, the lender will order an FHA-approved appraisal to confirm the property’s value and ensure it meets FHA standards. This appraisal helps validate the loan amount and the equity available for cash-out.

Upon successful completion of the underwriting review, the loan is approved, and the borrower receives a Loan Estimate document detailing the terms and costs. The next step is the closing, where all final documents are signed. For many refinance transactions on a primary residence, the Truth in Lending Act provides a three-day right of rescission, allowing borrowers to cancel the agreement within three business days after signing. This period begins after the borrower receives the signed contract, the Truth in Lending disclosure, and two copies of the notice explaining the right to rescind.

After the closing is complete and, if applicable, the three-day rescission period has passed, the cash-out funds are disbursed to the borrower. The timing of the funding depends on the lender’s procedures and whether the right of rescission applies to the specific transaction. Once disbursed, these funds become available for the homeowner to use.

Associated Costs and Use of Funds

An FHA cash-out refinance involves several costs that borrowers should consider. A mandatory expense is the Mortgage Insurance Premium (MIP), which includes both an upfront and an annual component. The upfront MIP (UFMIP) is 1.75% of the loan amount and is typically paid at closing, though it can be financed into the new loan. The annual MIP varies based on factors like loan term, loan-to-value ratio, and loan amount, generally ranging from 0.15% to 0.75% of the loan amount. This annual premium is divided into monthly installments and added to the mortgage payment, continuing for the life of the loan unless a down payment of 10% or more was made, in which case it may be removed after 11 years.

In addition to MIP, borrowers will incur closing costs, which typically range from 2% to 6% of the loan amount. These costs encompass various fees, such as origination fees charged by the lender, appraisal fees, title insurance, recording fees, and attorney fees. Borrowers have the option to pay these closing costs out-of-pocket or, if the loan-to-value ratio permits, roll them into the new mortgage. The new, larger loan amount will also be subject to prevailing interest rates, which affect the total cost of borrowing over the loan’s term.

Once the cash-out funds are disbursed, the FHA generally does not impose restrictions on how the money is used, provided the use is legal. Homeowners commonly utilize these funds for a variety of purposes. These often include significant expenditures such as home improvements, which can increase the property’s value. Other frequent uses involve consolidating higher-interest debt, such as credit card balances or personal loans, to streamline finances. The funds may also be applied towards educational expenses, unexpected medical bills, or other substantial personal needs.