Homeowners with a lot of equity in their homes, but lower credit scores, might benefit from the FHA cash-out refinance.
You can use FHA cash-out refinance proceeds to pay off debt, complete home improvements, or simply put money in your pocket. There are no limitations on what you can do with the money.
Is the FHA cash-out program worth it?
This program is best suited for those with substantial equity in their homes who need a large sum of cash.
Because closing costs on all mortgages can be high (think $5,000 or more) it’s not usually a good idea to get an FHA cash-out loan if you need just $5,000 or $10,000.
However, if you need $30,000 or more and have enough home equity, this program could be worthwhile.
There are not many home loans that allow lower-credit borrowers to receive cash at closing. Conventional loans and HELOCs require good-to-excellent credit scores to qualify for decent rates. But FHA lenders require a score of just 580 or even down to 500 in some cases.
FHA cash-out refinance guidelines
To get an FHA cash-out refinance, you do not have to have an FHA loan currently. You can refinance out of any kind of loan or get cash from a free-and-clear property as long as you meet guidelines.
- Maximum 80% loan-to-value (LTV) based on a current appraisal
- 580 minimum credit score (500 in some cases)
- Up to 56.9% maximum DTI
- The home has been your primary residence for the previous 12 months
- No non-occupant co-borrowers
- If a manufactured home, it must be permanently installed for 12 months
- All mortgages on the property have been paid on time for 12 months. For newer loans, 6 months of payments are required
- Loan limits of $472,030 to over $2 million depending on area and number of units.
- The mortgage must be paid current up to the month before closing
You don’t need any documentation to start the application process. Later on, you’ll need to supply:
- Two-year employment history or equivalent education
- Paystubs and W2s, or tax returns if self-employed
- Bank statements and other asset documentation
- An appraisal showing the property’s current value (lender to order)
- A credit report pulled by the lender
- Proof of on-time mortgage payments if the mortgage is not on the credit report
- Utility bills or pay stubs to prove you have lived in the home for 12 months
More documentation may be required depending on your situation. For example, you may need a gap in employment explanation letter to verify stability of income.
Uses for FHA cash-out funds
You can use FHA cash-out funds for just about any purpose
- Home improvements
- Debt consolidation
- Emergency expenses
- Purchase a rental property
- Start a business
- And more
The lender may ask the purpose for the cash. This isn’t to approve or deny the loan; it is simply for federally-mandated reporting reasons.
FHA cash-out mortgage rates
Generally, you’ll get much better refinance rates using FHA versus conventional, especially if you have a credit score below 740.
Conventional loan agencies Fannie Mae and Freddie Mac charge very high fees for cash-out refinances, especially for lower-credit applicants. These fees translate into higher rates.
For example, a borrower with 640 score would likely get a rate about 1% to 1.5% higher for a Fannie Mae conventional cash-out refi. In addition, the borrower would need to pay points.
Lenders can sometimes offer FHA cash-out rates without points, and at much lower rates, thanks to lenient guidelines.
An FHA cash-out refinance will require upfront and monthly mortgage insurance, even though loan-to-value is 80%. With an 80% conventional loan, you do not need upfront or monthly mortgage insurance.
Here are FHA’s mortgage insurance rates at 80 LTV.
|FHA cash-out mortgage insurance per $100,000 in loan amount||Percentage|
FHA cash-out loan limits match FHA limits for purchase and no-cash refinances.
|Standard||High-cost area||AK, HI, Guam, VI|
Conventional cash-out vs. FHA cash-out pros and cons
FHA cash-out pros
- Lower credit score minimums
- Lower mortgage rates
- Higher DTI maximum
- Use the cash for any purpose
FHA cash-out cons
- Limited to 80% loan-to-value
- Upfront and monthly mortgage insurance required
- Lower loan limits than conventional
Conventional cash-out pros
- Higher loan limits
- No mortgage insurance at 80% LTV
- Use cash for any purpose
Conventional cash-out cons
- Minimum 620 credit score
- High mortgage rates and fees for lower credit
- Lower DTI maximums
- Harder to qualify for
FHA cash-out after inheritance
If you inherited a property, you do not have to live in the home as a primary residence for 12 months to use an FHA cash-out refinance.
You can inherit a home and apply for a cash-out loan immediately.
The exception is when you rent out an inherited home at any time. If you do, you must occupy the home for 12 months before you’re eligible for FHA cash-out.
FHA cash-out on a free and clear property
Fully paid-off homes are eligible for the FHA cash-out program. Homes with a mortgage require 12 months of on-time mortgage payments, but there is no such requirement for free-and-clear homes.
How to get an FHA cash-out refinance with low credit
Most lenders require a 580 minimum credit score to be eligible for an FHA cash-out loan, although some may go lower. Conventional loans and HELOCs require anywhere from 620 to 720.
The lender will review your file after you apply and run it through FHA’s automated system. You may receive approval right away. If your loan is not eligible for automated underwriting, there’s a chance the lender can manually underwrite the loan. This is when a human underwriter examines the file to see if it meets FHA guidelines.
It’s worth applying for this program even if you think your credit is too low or have experienced credit events in the past.
How to Get an FHA Cash-Out Refinance After Bankruptcy
- Chapter 7 bankruptcy: Typically 2 years from the discharge date if credit has been re-established.
- Chapter 11 bankruptcy: You are eligible after 12 on-time payments with permission from the trustee.
- Chapter 13 bankruptcy: You’re eligible when you’ve made 12 payments toward the repayment plan. The bankruptcy does not need to be discharged. You can use cash-out funds to pay off the bankruptcy. You need permission from the trustee.
FHA cash out after forbearance
Getting an FHA cash-out loan after forbearance is possible. You must:
- Complete the forbearance plan
- Make 12 on-time mortgage payments since completing the plan
FHA cash-out: Effective but little-known tool
Not many homeowners realize that a cash-out refinance is available to them, even without perfect credit.
This program can pay down or pay off debt, give you extra cash for emergencies, and otherwise give you financial breathing room.