HUD slashes FHA cash-out refinance LTV limit. What you should do now

FHA cash-out LTV limits reduced

FHA cash-out refinancing rules will change starting September 1, 2019.

The new rule will limit cash-out refinances to 80% of a property’s fair market value. This is down from the old standard of 85%.

For many potential borrowers, the new FHA rule will have a significant impact. For a $300,000 property with a current mortgage balance of $150,000 the change looks like this:

The difference between the old cash-out limit and the new one is $15,000 in this example. If you’re trying to get the largest check possible from your equity this is a very big deal.

If you are in need of an FHA cash-out loan at 85% LTV, apply by August 30, 2019 (the last business day in August).

Cash-out refinancing to become harder for those with lower equity

The new LTV limit is an even bigger deal if you only have around 20% equity in the home.

Previously, you could feasibly get an FHA cash-out loan. You would have 5% of your equity available to tap, for instance, if you had 20% equity.

Now, FHA is not an option. Neither are Fannie Mae or Freddie Mac conventional loans, which also max out at 80% LTV.

Here’s what old-vs.-new scenario looks like for lower-equity borrowers.

How do I apply before the deadline?

The new rule goes into effect for all new FHA case numbers starting September 1, 2019.

A case number is an FHA-specific identifier that is generated, typically, the day you apply for a new FHA loan.

So, essentially, you must apply by August 30, 2019, which is the last business day in August.

But you might not want to wait that long. Lenders are sure to be busy generating FHA applications that day. Plus, the last day of the month is busy for lenders anyway.

The best advice is to apply with a lender the moment you read this if it is still August 2019.

Consider a personal loan after August 30, 2019

Reading this after August 2019? Have low equity? You may want to consider a personal loan.

A personal loan does not require equity in the home, as FHA cash-out refinances do. And, you receive funds faster. Closing costs, if any, are a fraction of those that come with an FHA loan.

Personal loans are becoming a common way to attain a good amount of cash quickly, without the weeks-long process of getting approved for a cash-out mortgage.

FHA cash-out refinancing

The big question is why the government is changing the policy for FHA cash-out refinancing. After all, the bigger the loan the bigger the mortgage insurance premiums the FHA collects from borrowers.

If you get an FHA mortgage you have to pay two forms of insurance.

First, there is the upfront mortgage insurance premium (the upfront MIP). It’s equal to 1.75% of the mortgage amount. You do not have to pay this sum in cash. It can be added to the loan balance.

Second, there is an annual mortgage insurance premium (the annual MIP). At this time it’s equal to .85% of the loan amount. This charge is included with the monthly payment.

The money collected by the FHA is placed in a reserve fund. It’s called the Mutual Mortgage Insurance Fund (MMI Fund). If someone doesn’t pay back their FHA loan the lender is paid off with money from the MMI Fund.

The FHA program has been hugely successful. In fiscal year 2018 reserves for FHA forward mortgages had a positive economic net worth of $46.8 billion. The situation with FHA reverse mortgages was very different. They had a negative economic net worth of $13.63 billion.

Cash-out refinance worries are building at HUD

If the FHA reserves are so strong then why change the standards for FHA cash-out refinancing? The answer is that the FHA is an insurance program. You have to look at how the FHA is doing today and how it might look in the future.

According to HUD there were 43,052 FHA cash-out refinances in FY 2013. Five years later the number rose to 150,883 FHA cash-out refinances. That’s a 250% increase.

If you’re in business you generally like to see sale increases. If you’re in the insurance business you get nervous. All that additional coverage represents potential claims. It’s nice right now to have that much interest in FHA cash-out refinancing but what if the economy sours? Will the government be able to pay off all lender claims? Maybe it’s a good idea to reduce cash-out refinancing levels.

“Studies,” said HUD, “have shown that a significant increase in foreclosures may have been the result of a high number of cash-out refinances completed prior to the collapse of the housing market.”

The matter of equity

HUD is effectively saying that the FHA program will have less risk if borrowers have more equity.

According to HUD, reducing the cash-out limit will be “a prudent measure in order to strengthen the equity position of cash-out refinances and reduce loss severities in the event of default, stay ahead of any potential future shift in the housing market and better support FHA’s mission of providing access to sustainable homeownership that builds equity.

This makes a lot of sense but also raises a question. FHA borrowers can now get financing with as little as 3.5% down. Using the logic applied to FHA cash-out refinancing what about down payments? Will we see an increase in the FHA down payment standard?

The VA option

If HUD is going to claim that studies justify higher equity levels for cash-out refinancing then it might want to take a look at the VA cash-out program. VA loans are available with nothing down. Zero. At the same time VA loans have lower delinquency levels than FHA financing. Far lower. According to the Mortgage Bankers Association, the FHA delinquency rate in the first quarter was 8.93% versus 4.37% for the VA program.

How does the VA do it? It’s debatable, but here’s one difference between the two programs. The VA has a “residual income” standard while the FHA does not. That means to get a VA loan you need a certain amount of free cash left over after expenses. How much you need depends on family size, loan amount, and geographic location.

In addition to a debt-to-income ratio (DTI), why not a residual income standard for FHA loans? It’s a risk reducer that works.

Apply for an FHA cash-out loan

Despite new LTV requirements, FHA cash-out loans are still a good value, especially if you have lower credit.

Get started on your FHA cash-out loan below, even after the new rules go into effect.

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