Cash-Out Refinance Rules: Guidelines and Insights

You always want to be careful in taking any kind of equity out of your home. If you absolutely need to, you can do so by doing a cash-out refinance on your current mortgage. It can often be a more secure way to pull cash out of your home, without having to resort to either a second mortgage or a home equity line of credit.

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Conventional Cash-out Refinance Rules

You can borrow as much as 80% of the current market value of your home on a cash-out refinance. The new first mortgage must pay off any existing mortgages on the property, including either a first mortgage or a second mortgage or home equity line of credit. Any amount of the new first mortgage that exceeds the existing indebtedness will represent your cash-out. Naturally, if there are no existing liens on the property, you’ll be entitled to the full proceeds of the new mortgage.

To be able to do a cash-out refinance, the property must have been owned by the homeowner for a minimum of six months. However, there is no waiting period if the homeowner received the property either through inheritance or was legally awarded the property through divorce or separation.

Your home cannot be currently listed for sale. That means you will be unable to take a loan against the property to use it for say, the down payment on a new home. If the property has been listed for sale within the past six months, the new mortgage will be limited to not more than 70% of the value of the property.

Maximum Loan-to-Values (LTVs)

Maximum loan amounts are determined by a percentage of the property value, which is referred to as the loan-to-value ratio, or simply LTV. That is the amount of the new mortgage, divided by the market value of the property. For example, if the property value is $200,000 and the new loan will be $150,000, the LTV will be 75%.

The market value of the property is determined by a current appraisal.

LTV’s for various property types and loan types are as follows:

For owner-occupied homes:

Fixed rate mortgages: For a one unit property the maximum LTV is 80%. On 2-4 unit properties, the maximum is 75%

Adjustable rate mortgages (ARM): For a one unit property the maximum LTV is 75%. On 2-4 unit properties, the maximum is 65%

For second homes (1 unit only):

Maximum 75% on fixed rate mortgages, and 65% for an ARM.

For investment properties:

Fixed rate mortgages: For a one unit property the maximum LTV is 75%. On 2-4 unit properties, the maximum is 70%

ARM: For a one unit property the maximum LTV is 65%. On 2-4 unit properties, the maximum is 60%

Acceptable Uses for the Cash from a Cash-out Refinance

When you do a cash out refinance, the proceeds can be allocated as follows:

• Payoff of existing first or second mortgage, or home equity line of credit
• Closing costs on the new mortgage
• Real estate and insurance escrow on the new mortgage
• Cash-out for any purpose, including home-improvement, education, major asset purchases, or debt consolidation (among other purposes)

FHA Cash-out Refinance Rules

You can also do a cash out refinance using an FHA mortgage, and one of the benefits that they have more relaxed guidelines. Borrowers are generally able to qualify with both lower credit scores and higher debt-to-income (DTI) ratios.

FHA also allows homeowners to take higher LTV mortgages than conventional loans. You can borrow up to 85% of the value of your home under a cash-out refinance, compared with a maximum of 75% with a conventional mortgage. However, unlike conventional loans, FHA cash out refinances can only be taken on your primary residence, and not second homes or investment properties.

The minimum length of ownership of your property is six months. However, if you have owned the property for less than 12 months, the value of the property will be the lower of the appraised value or the original purchase price. If you believe that the value of the property has increased, you’re better to wait until at least 12 months have passed since the original purchase. The loan will be for 85% of the value plus allowable closing costs.

Similar to conventional loans, an FHA cash-out refinance can be used to pay off the current first mortgage, any subordinate loans, closing costs, and cash out for other purposes.

Your mortgage payment history will be one of the most critical qualifying factors with an FHA cash-out refinance. To qualify, you cannot have any more than one 30-day late payment in the past 12 months.

If you are considering taking cash out of your home, and are looking into either a second mortgage or a home equity line of credit, take a long hard look at doing a new first mortgage as a cash-out refinance. It will give you an opportunity to have just one payment on the property, and to lock in your interest rate and payment for the life of a loan.