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Cash-out refinance rules for FHA, VA, conventional and reverse mortgages

Peter Miller
The Mortgage Reports contributor

In this article:

  • How cash-out refinance rules work
  • Cash-out refinance rules for conforming, FHA, USDA and VA home loans
  • Cash-out refinancing with a reverse mortgage

A cash-out refinance can put real dollars in your pocket. But you need to know the rules and practice good strategy.

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Home values are up

If you’ve owned real estate for the past few years, the odds are that your net worth has significantly increased. According to the National Association of Realtors, existing home values nationwide increased from $196,230 in June 2009 to $276,900 in June 2018.

That’s $80,670 in additional equity on average. Add in mortgage amortization, the reduction of loan balances with each monthly payment, and many homeowners have more than $100,000 in equity.

What’s a cash-out refinance?

With a cash-out refinance, you don’t move or sell. But you can take out some of the equity for such things as starting a business, paying tuition or making home improvements.

This can be done by refinancing the existing mortgage, adding a second mortgage or using a home equity line of credit (HELOC). Owners age 62 and above might want to consider a reverse mortgage.

Cash-out refinance rules

There’s no single set of cash-out standards. How much you can get from your property depends on the program used. However, many lenders will not let you take out a cash-out refinance to buy a new home and then immediately sell the one you just refinanced. You may have to hang onto it for at least 12 months.

For instance, let’s look at Owner Smith. Smith bought a property for $200,000 with 5 percent down. It has a fair market value today of $400,000. The original mortgage – $190,000 – has been reduced to $170,000 as a result of monthly payments. Subtract $170,000 from $400,000, and the basic equity amount is $230,000.

Related: Loan-to-value (LTV) explained in plain English

Can Smith really get $230,000? The answer is generally no, and here’s why.

Only a portion of real estate equity is available to most owners. To find out how much you can get, you need to know the cash-out refinance rules.

A cash-out refi requires a complete mortgage application. If you have owned the property for less than a year, special rules can apply.

The loan must be current. You must have good credit. The new loan cannot exceed acceptable debt-to-income ratios. If you refinance and your equity dips below 20 percent you will need mortgage insurance.

Cash-out strategies

There is no single cash-out approach which works for everyone in all cases. Instead, you have to look at your situation to see what works best for you. Here are some examples.

You have an existing mortgage with a low-interest rate. In this case, it may be best to keep the current mortgage in place and add to your financing with a second mortgage or a home equity line of credit (HELOC) to pull cash out of the property.

Related: 4 alternatives to a cash-out refinance

You have an existing mortgage with a high rate of interest or an ARM. In either case look for replacement financing. New financing with a lower rate can cut monthly costs, while conversion from an ARM to fixed-rate financing will protect against future rate increases. With a lower rate, you may be able to get additional cash from the property.

You have an existing home equity line of credit (HELOC). It has been in place for several years. The draw period which allows you to take out money is about to end, and the repayment period is about to begin. You have a $100,000 balance at 6.6 percent and will be required to pay $876.61 per month for principal and interest to pay off the loan.

This amount is in addition to current payments for your first mortgage. In this case, you want either a new second mortgage or cash-out refinance to replace both the existing first mortgage and the HELOC. The longer term will result in smaller monthly payments. With sufficient equity, you can get cash from the property.

Reverse mortgages

You may be able to get cash-out with a reverse mortgage. In this example, you’re age 62 or older. You can sell the property and downsize. Or stay in place and get a reverse mortgage. A reverse mortgage requires no monthly payments for principal and interest. With a reverse mortgage and enough equity, you can pay off your existing mortgage and get additional cash.

Related: HECM reverse mortgage (who should consider it?)

Reverse mortgages are complex. Speak with a fee-only financial planner or an attorney who specializes in elder law to see how a reverse mortgage can impact your overall finances.

Conforming cash-out refinance rules

Conforming mortgages are loans which meet Fannie Mae and Freddie Mac standards. They typically require 20 percent equity, and the fees for cash-out refinancing are higher. Guidelines are also tougher, with higher minimum credit scores. In the case of Smith’s $400,000 house, this means as much as $320,000 can be available.

Related: cash-out refinance for rental property

At first, the 20 percent equity requirement might seem like a drawback when compared with the FHA (15 percent equity required) or the VA (no equity required, 100 percent financing available). However, with 20 percent equity, there’s no requirement for mortgage insurance. This is a big savings, both monthly and over the life of the loan.

FHA cash-out refinance rules

The FHA insures mortgage loans. That insurance allows borrowers to purchase with as little as 3.5 percent down in most cases. It also allows borrowers to refinance. There are several basic FHA refinance options.

If you now have non-FHA financing, you may replace your current mortgage with a new FHA-backed loan. or you can replace an FHA mortgage with a new FHA mortgage.

The new financing can represent as much as 85 percent of the property’s value. For a $400,000 home, you can obtain up to $340,000 with an FHA refinance. if you pay off a $170,000 mortgage balance, you could get up to $170,000 in cash.

You must re-qualify for a mortgage under FHA guidelines, which are often more flexible than those of other programs. You also pay FHA mortgage insurance, so this may be a more expensive option.

VA cash-out refinance rules

The VA has two basic refinancing options. The “Interest Rate Reduction Refinance Loan” (IRRRL) is essentially a rate-and-term refinancing option. The catch: no cash out is allowed.

The VA’s cash-out refinance loan is different. It allows cash-out refinancing in a big way. Under the VA program, qualified borrowers can refinance up to 100 percent of the property’s fair market value.

The VA essentially treats new loans and cash-out refinancing the same. In both cases, borrowers can get 100-percent financing. However, the VA Funding Fee for a cash-out refinance is set at 3.3 percent, higher than vets pay for a new loan.

USDA cash-out refinance rules

Like the VA program, USDA borrowers can get 100 percent refinancing. What they can’t get is cash out, an option not allowed under the USDA program.

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