The Federal Housing Administration’s home loan program is one of the three government backed loans and is also the most popular. The other two government backed loans are the VA and USDA programs. The FHA loan is also the favorite for first time homebuyers. There are several reasons for this popularity but primarily the minimum down payment is only 3.5 percent of the sales price and easier to qualify for compared to other low down payment options. But at some stage of the life of the loan, homeowners can decide it’s time to refinance an existing mortgage. What are some of the considerations for refinancing?
The obvious reason is to get a lower interest rate. Mortgage rates rise and fall over time and when someone buys a home and uses an FHA loan, it might be when rates are relatively high. Yet when rates fall back once again, homeowners may decide a refinance is a good idea. I can walk you through this decision making process to see if a refinance falls in your favor with a simple phone conversation. A refinance might also be a good idea when saving on interest with a shorter loan term. A shorter loan term, such as 10 or 15 years, will have higher monthly payments compared to a 30 year term but the amount of interest saved can be significant. Whatever the reason to refinance, it might also be a good idea to pull some equity out of the property in the form of an FHA cash out refinance.
The FHA cash out refinance is easier to qualify for compared to other types and follow the same basic guidelines as an FHA purchase loan. FHA requires a minimum credit score of 580 when the loan amount is between 3.5 and 10 percent of the value of the property. But with an equity position of 10 percent or more, the credit score requirements can fall all the way down to 500. The only major credit qualification other than scores is the payment history for the previous 12 months. When reviewing a credit report, there can be no payments made more than 30 days past the due date during that 12 month period. With the right credit score and no such 30+ late payments, it’s easier to qualify for an FHA cash out loan.
New guidelines for FHA cash out loans limit the new loan to 80 percent of the current market value of the property. This is a change from last fall when the maximum loan amount was at 85 percent. A brand new appraisal will also be needed. And speaking of closing costs, those can be rolled into the final loan amount with an eye toward the 80 percent maximum limit.
With an FHA cash out loan, there will still be an upfront and an annual mortgage insurance premium as with all FHA loans. The upfront premium is rolled into the primary loan balance and the annual premium is paid for in monthly installments. Further, debt-to-income limitations are set at 50 percent. This means that your mortgage payment, which includes taxes, insurance and mortgage insurance in addition to other credit obligations such as a car payment or credit cards, cannot exceed 50 percent of your gross monthly income.
The property must be occupied for at least 12 months and you can expect to provide some sort of documentation going back at least 12 months showing occupancy. A utility bill from one year ago with your name and address can fulfill this requirement.
With a cash out refinance, the loan will be fully documented. This means you’ll once again need to provide your most recent paycheck stubs covering a 30 day period along with your last two years of W2 forms. For self-employed borrowers, the last two years of tax returns and a year-to-date profit and loss statement is needed. This P&L can typically be performed by you or your accountant and does not have to be officially prepared by a licensed financial advisor or CPA in most cases. I can help put together a P&L for you.
Cash funds disbursed from the transaction can be used for any purpose. However, only the mortgage interest allotted toward funds used for home improvements can be eligible as an income tax deduction. Be sure to discuss any tax issues with a tax professional.
If you’re thinking of refinancing and it looks as if it’s something you can benefit from such as lowering a rate or changing a loan term, you might also want to think about pulling out a little extra cash along the way with an FHA cash out refinance.