With cash-out refinancing, you can use your home's equity without having to sell it. Whether you own free and clear or have a mortgage, you can cash out to improve your home, pay off high-interest debt, finance a business venture or build cash reserves. A cash-out involves paying off existing liens and pocketing part of what's left of your equity. You may qualify for a cash-out refinance with the Federal Housing Administration if you meet certain requirements
The FHA insures purchase and refinance loans made by approved lenders. Homeowners with low and moderate incomes and credit challenges use FHA loans to refinance because they have trouble qualifying under conventional loan standards. To reduce its risk, the FHA charges a mortgage insurance premium, which protects the lender and ensures that the FHA pays its claim if you default. Mortgage insurance is charged on all cash-out refinances except those involving a repayment term of 15 years or less.
A loan-to-value ratio compares the amount you borrow to your home's value. Expressed as a percentage, the LTV is important because it affects your interest rate and eligibility for a cash-out refinance. The maximum LTV allowed on an FHA cash-out is 85 percent. This means that after the cash-out is done, you must have at least 15 percent equity left in your home. The 85 percent LTV requirement also applies if you have a second lien in addition to the new FHA loan. These liens include second mortgages, home equity lines of credit and home equity loans.
Cash-out refinancing for debt consolidation is risky because it increases your loan balance. If your income hasn't increased but your monthly mortgage payment goes up, the lender is taking an even bigger chance. The FHA advises lenders that "careful evaluation of this type of transaction is required." You may not have any late payments on your mortgage in the past 12 months. You must have had your previous mortgage for at least six months. The FHA has forgiving guidelines when it comes to your credit score, requiring at least a 500 credit score for a cash-out refinance.
The FHA has benchmark debt-to-income ratios that limit your new housing payment. You can have a housing payment that uses up to 31 percent of your gross monthly income. Your total recurring debt may not exceeding 43 percent of your income. You may exceed these benchmarks if you have certain compensating factors. You must live in the property for a majority of the calendar year to cash-out refinance with the FHA. Your property may have up to four units. The FHA also limits the loan amount depending on where you live. You can look up the annual loan limit for your area on HUD's website.
- Comstock/Comstock/Getty Images