Make Tough Refinancing Work With an FHA Loan

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If you’re having trouble refinancing with a conventional loan, FHA loans — federally-backed mortgages that allow homeowners to get fair rates without the need for a large down payment — could be a good fit for your needs. In fact, borrowers that meet the FHA loan requirements may be able to secure a loan with as little as 3.5% down, and FHA loans can be used for initial home purchases or for refinancing. 

Thanks to federal backing, these loan types can help make tough refinancing and purchases work, as they alleviate some of the risks for the lender. They also loosen the restrictions in place for homebuyers or homeowners who are refinancing, as the credit scores and other qualifications are less stringent than they are with other types of loans.

While an FHA loan is federally backed, they are issued through private lenders approved to handle these types of loans. Rates will vary based on the private lender you choose, but each lender follows the same general FHA guidelines. It’s important to shop rates and repayment terms to find the best solution for your financial needs. The maximum loan limits for FHA loans for 2020 are between $331,760 and $765,600, but the actual limit depends on the area you are looking to buy in or refinance.

FHA mortgage loans can also be used as a part of the FHA cash out program. This program allows homeowners to refinance and withdraw the equity they’ve built in their homes as cash, provided that they have at least 20% equity built up in their home and meet a few other criteria laid out in the FHA guidelines. This type of refinance increases your debt obligation, though, so it’s important to fully understand the program before moving forward. That being said, the additional cash can be used for things like debt consolidation, home improvements, medical bills or any other financial uses. You don’t have to have an existing FHA loan to take advantage of the program.

How to qualify for an FHA loan

  • Credit score above 500 — In order to qualify for an FHA loan, you need to have a credit score above 500. However, you will need a credit score above 580 to qualify for the maximum benefit, and some lenders have different credit score requirements for this type of loan. People with a score between 500 and 579 will have to put 10% down instead of the 3.5% required for all other borrowers.
  • Debt to income ratio below 43% — Whether you are getting a new FHA loan or an FHA refinance, the lender will need to look at the relationship between your debt and income. Your FHA debt to income ratio must be below 43% to qualify. If you are carrying too much debt and not making enough income to offset it, you won’t be able to use this program.
  • Mortgage insurance — FHA loans will require you to get mortgage insurance for the life of the loan. This requirement only lasts for other types of loans until the homeowner has built 20% equity in the home, but it stays with an FHA loan for the duration of the term.

If you’re in need of some additional funds for an upcoming purchase or unexpected expenses, the FHA cash-out refinance program may be an option. The program allows homeowners to take out a new loan for up to 80% of the value of their current loan. The difference in amounts between the two loans is paid out to the homeowner in cash, generally a few days after closing. For people in need of cash, this may be an affordable option worth considering.

The bottom line

FHA loans are a unique, federally-insured program that can help a lot of people get into their own homes or refinance when other options aren’t available. Because the program has federal backing, it lowers the risk to the private lender, which allows the lender to be more liberal in approving financing for you. While FHA loans do have some drawbacks, they’re a great tool for many people to get into a home.

If you’re an existing homeowner looking to get some extra cash, an FHA cash-out refinance may also be a great option. As long as you have at least 20% equity in your home and meet the other requirements of your lender, you can get access to some quick cash at an affordable rate.