Learn what is the FHA cash-out refinance plan. Discover the requirements, pros and cons, and more with our detailed guide.

If you’re a homeowner with a mortgage and need money, you can take advantage of the Federal Housing Administration (FHA) cash-out plan for refinancing. It’s a type of loan that allows you to refinance your home and use its equity to borrow more money without needing to take out another mortgage.

In this article, I will answer all the questions you may have about FHA cash-out plans – how they work, what makes them different from conventional cash-out refinances, how much you can borrow, and whether it’s a suitable option for you.

What Is FHA Cash-Out Refinance Plan?

An cash-out refinance backed by the FHA pays off your existing mortgage and replaces it with a bigger loan based on the equity in your home.

Most importantly, the FHA, a government agency, ensures this new mortgage.

These cash-out plans typically have lower interest rates, and because they’re insured by the FHA, the credit score required is also relatively low.

In simpler words, with an FHA cash-out plan, you refinance your mortgage and borrow a bigger amount using the equity in your home.

You use part of that to pay off the existing loan, and you can cash out the rest. That cash can be used for various things, such as home renovations or debt consolidation.

How the FHA Refinance Cash-Out Works?

FHA cash-out refinance is offered by lenders and banks approved by the agency. The process is similar to a regular mortgage in that you must satisfy certain requirements to qualify. The loan amount is dependent on the value of your home and the outstanding mortgage loan.

For example, you have a home worth $300,000, and you owe $200,000 in your current mortgage balance.  With an FHA cash-out refi, you may be able to borrow $240,000 (equivalent to 80 percent of the value of your home). Of this new mortgage loan, $200,000 will pay off the original mortgage. You can cash out the remaining $40,000. You will then start making monthly payments on the new total $240,000 loan.

The interest rate on this new loan will depend on the current rates. However, an FHA loan tends to have lower interest rates than a conventional cash-out refinance mortgage (typically, the difference is 0.1 to 0.15 percent).

FHA Cash-Out Requirements

To qualify, you must meet the minimum requirements per the FHA cash-out rules. However, although the FHA sets minimum requirements, lenders can set their own.

Here’s what you need to qualify for an FHA refinance for cash-out:

Credit Score

FHA cash-out refinance mortgage has some of the lowest credit score requirements.  According to the official FHA refinance cash-out guidelines, applicants can apply with a credit score as low as 500.

However, as I mentioned before, lenders can set their own requirements. Most lenders usually require a minimum credit score of 620, but some may require less.  A credit score is also important for determining the rate of the new mortgage, so the higher your credit score, the lower the rate you’ll get.

Debt-to-Income (DTI) Ratio

Like many other loans, your DTI is also important when applying for an FHA cash-out mortgage plan.

Typically, the DTI shouldn’t be higher than 43 percent. On the other hand, if the lender is just considering the mortgage payments, the DTI must be under 31 percent.

Loan-to-Value (LTV) Ratio

LTV is the difference between the amount you owe on your home and its value. The FHA cash-out refinance max LTV is 80 percent. This means that you must not owe more than 80 percent of your home’s value.

Occupancy

The FHA cash-out guide says that only homeowners who live in their property can apply for an FHA-backed refinancing. So, you must prove that you’ve lived at that address for at least the last 12 months.

Payment History

Another requirement to qualify for an FHA cash-out refi is to be in good standing with your current mortgage payments. There must not be a late payment in the last 12 months.

How Much Can You Borrow with FHA Refinance Cash-Out?

The amount you can borrow with cash-out refinance with FHA depends on a variety of factors. However, the two most important factors are your home’s current value and the equity you’ve built, both of which are related.

You can’t borrow more than 80 percent of your home’s current value. In other words, you must have 20 percent equity in your home at the time of loan application.

Let’s suppose your home is worth $400,000. You can borrow up to $320,000, which is 80 percent of the home’s value.

Again, part of that will be used to pay off your existing mortgage. So, if you owe less, you walk away with more cash.

Using the example above, if your current mortgage balance is $200,000, you can cash out $120,000 minus the closing costs.

That said, you don’t necessarily have to cash out all of the $120,000; you can borrow a smaller amount depending on your need.

Besides the above, there are caps from the FHA on the amount you can borrow regardless of the value of your home. These caps vary by area and are increased periodically.

In 2024, the maximum FHA loan limit for a single-family home is $498,257 in most areas. For high-cost areas, the limit is well above $1.1 million. You can check the FHA loan limits by area here.

What Are the Costs of FHA Cash-Out Refinance?

Several closing costs are associated with an FHA cash-out refinance plan, which can range from two to six percent of the total loan amount. You must factor in these costs when deciding, as they’ll be subtracted from the cash-out amount.

These costs include several things, such as title search, credit check, appraisal fee, etc.  A significant part of the cost is the mortgage insurance. You’re required to pay the FHA mortgage insurance premium of 1.75 percent upfront.  After that, you’re supposed to pay the insurance premium each year.

Although an FHA cash-out refinance might appear as a straightforward means to acquire additional funds, it’s crucial to recognize that it entails its own financial commitments. Apart from bearing closing costs, typically ranging from 2% to 4% of the loan amount.

Consider a hypothetical scenario where you’re refinancing $250,000. In this case, closing costs could vary from $5,000 to $10,000, in addition to an extra $4,375 for the mortgage insurance premium. These closing costs are separate from various other charges your lender may impose, such as those related to appraisals and title searches.

Pros and Cons of the FHA Cash-Out Plan

A cash-out refinance mortgage backed by the FHA can have several benefits. Let’s compare the advantages and drawbacks to understand better who it’s best for.

Pros

• Flexible requirements: You don’t have to have a high credit score or a lot of equity in your home to qualify for an FHA cash-out refinance. Similarly, your current mortgage doesn’t have to be an FHA loan, it can be from any type of mortgage and lender.
• Lump sum cash out from home equity: If you’ve built equity in your home, you can apply for an FHA cash-out plan and receive a considerable lump sum. That cash can be used for home improvement, paying off other debt, or sending your kid to college.
• Ability to sell: You can sell your home to a buyer who qualifies as per the FHA cash-out refinance guideline and can take over the loan.
• Lower rates: FHA cash-out refinance rates are typically lower than conventional refinance products. However, your credit score is vital in determining the final rate offered.

Cons

• Property must be primary residence: You can only apply for an FHA cash-out refinance on a home you currently live in and have been residing in for at least the past year. So, it’s not useable with investment properties.
• More debt: Although a viable option to use home equity for cash, you’re essentially taking on more debt with an FHA cash-out. That also means that your monthly payments may increase going forward.
• Closing costs: You also have to shoulder the closing costs when refinancing your home with an FHA cash-out plan. This can be as high as six percent of the total loan amount. Also, mortgage insurance is mandatory with FHA loans, which you potentially avoid with a conventional loan.

Frequently Asked Questions

Can you do a 100% cash-out refinance with FHA?

The maximum LTV for FHA cash-out refinance is 80 percent, and that’s also the limit you can borrow. You can only get a cash-out refinance of up to 80 percent of your home’s value.

Even with conventional loans, lenders don’t allow homeowners to cash out 100% of their equity.

How long does the FHA cash-out refinancing process take?

The processing time for an FHA cash-out refinance plan can vary depending on location and other factors like documentation preparation or appraisal.

Normally, you can expect up to 48 days for the application to be processed and approved and for you to receive the cash amount.

What are the alternatives to a cash-out refinance?

Home equity loans and HELOCs are alternatives to cash-out refinancing for your home. Unlike a refinance, these alternatives are like second mortgages and don’t replace your original mortgage.

How are funds dispersed for FHA cash-out refinance?

You have the option to receive your cash back through either a wire transfer or an overnight check. If you prefer a wire transfer, you’ll need to complete a form provided by the notary, specifying your bank details. Failure to fill out this form during signing will result in the title company sending your funds via an overnight check.

Final Thoughts on the FHA Cash Out Plans

The FHA, a governmental body, aims to enhance homeownership and foster stability in the housing market. To achieve this, it supports loans with more flexible criteria compared to conventional loans. If traditional funding sources are unavailable to you, an FHA cash-out plan could be a suitable option.

A cash-out refinance mortgage can be a viable option for homeowners who need significant cash for major life expenses.

Moreover, under specific conditions, a borrower can seize the opportunity to reduce their interest rate, adjust the loan term, and switch from an adjustable rate to a fixed rate, alongside accessing surplus funds. Finally, the FHA cash-out refinance loan program permits borrowers to refinance up to 85% of their home’s value.

While there aren’t any restrictions on how you use the cash, I recommend using it for home renovation and upgrades or consolidating debt. The latter can help improve your credit score and simplify your debt management.

Another great thing about this type of loan is that you may qualify for it with a relatively lower credit score. You may even be able to tap it with a score lower than 600, albeit with a higher interest rate.