Homeowners with minimal equity may want to refinance for several reasons. Refinances makes the most sense for borrowers who can reduce their monthly payments or otherwise obtain better loan terms. The Federal Housing Administration, which offers various types of refinance programs, insures loans made by private lenders, protecting them against default. You need only 3.5 percent equity for an FHA "rate and term" refinance, which is designed to change your loan's terms without cashing out equity.
No Cash Out Guidelines
Also known as a "no cash out" refinance, the FHA's rate and term refinance program lets borrowers get a more desirable loan and receive a maximum of $500 cash back at closing. The FHA refinance loan can pay off a conventional, non-government-backed loan, a government-guaranteed loan such as a Veterans Affairs or Department of Agriculture mortgage, or an existing FHA loan. FHA rate and term refinances involve credit checks, income and asset analysis, and a property appraisal.
Cash Not Needed to Close
You pay closing costs on a rate and term refinance. These fees, which pay for lender, escrow, title and prepaid items at closing, on average cost between 3 percent and 5 percent of the loan amount. Most borrowers add the closing-cost amount to the new loan's principal balance. By rolling the costs into the FHA-backed loan, you pay a minimal amount or nothing out of pocket. The lender may require you to pay for an appraisal and home repairs before closing. FHA loans require you to pay an annual mortgage insurance premium and a one-time up-front mortgage insurance premium. You pay the up-front premium at closing, and most borrowers also roll this cost into the new loan.
How Cash-Back Happens
The FHA allows you to take out a loan amount that equals the lesser of 97.75 percent of your home's value or the total existing debt, including loan balance and closing costs. In certain cases, your loan amount may equal up to 100 percent of the appraised loan value after including the up-front mortgage insurance premium in the balance. You receive up to $500 cash back after closing a rate and term refinance if the estimated closing costs exceed the actual amount needed to close. This can occur when the escrow holder includes a pad, or overestimates fees, when calculating closing costs and the final loan balance. Escrow agents often pad the balance to ensure that escrow has enough money to cover all costs. When closed, escrow refunds you the difference between estimated costs and actual costs -- up to $500 -- instead of reducing the loan balance.
Consider the Alternatives
The FHA's other refinance programs -- the streamline refinance and the cash out refinance -- can result in cash back. A streamline refinance, which can be completed without an appraisal or credit qualifying, also allows a maximum of $500 cash back after "minor adjustment at closing." The purpose of a cash out refinance, as indicated by its name, is to provide cash proceeds to you at closing. You need to have at least 15 percent equity left after the refinance, and you can cash out several thousands of dollars -- as your home's equity permits -- to use as you please. The FHA sets loan limits based on where you live, which also has a bearing on the maximum amount you can cash out.
- Department of Housing and Urban Development: General Information on Refinance Transactions
- Bankrate: Closing Costs: States Ranked
- Closing Costs on FHA Home Loans: 2013 Update
- PrimeLending. "Types of Refinance Loans." Accessed April 28, 2020.
- Freddie Mac. "Working With Your Lender to Refinance Your Loan." Accessed April 28, 2020.
- Consumer Financial Protection Bureau. "Request Multiple Loan Estimates." Accessed April 28, 2020.
- Consumer Financial Protection Bureau. "Is There Such Thing as a No-cost or No-closing Loan or Refinancing?" Accessed April 28, 2020.
- Freddie Mac. "Costs of Refinancing." Accessed April 28, 2020.
- Redfin. "What Is a Yield Spread Premium?" Accessed April 28, 2020.
- Consumer Financial Protection Bureau. "Should I Refinance?" Page 2. Accessed April 28, 2020.
- Wells Fargo. "Thinking About Refinancing?" Accessed April 28, 2020.
- Citi. "Thinking of Refinancing?" Accessed April 28, 2020.
Karina C. Hernandez is a real estate agent in San Diego. She has covered housing and personal finance topics for multiple internet channels over the past 10 years. Karina has a B.A. in English from UCLA and has written for eHow, sfGate, the nest, Quicken, TurboTax, RE/Max, Zacks and Opposing Views.