A decade has passed since the housing crisis, when many homeowners were led into foreclosure after using too much of their home equity for vacations and bills. In 2009, the Federal Housing Administration (FHA) adjusted its limits on FHA borrowers to reduce the prevalence of cash-out refinancing.
Cash-out refinancing refers to homeowner refinancing their mortgage to a higher balance than they currently owe to access their equity. For example, if the balance the homeowners want to refinance is $200,000 and the home is valued at $400,000, a homeowner could take out a new loan for $300,000 and use the $100,000 to pay off debt, pay college tuition, make a home improvement or spend the money in other ways.
Beginning Sept. 1, FHA borrowers will now be limited to cash-out refinancing a maximum of 80 percent of their home value. For example, on a home valued at $400,000, the maximum loan amount would be $320,000. In 2009, the limit was set at 85 percent of the home value, but before that borrowers could do a cash-out refinance of up to 95 percent of their home value.
The new 80 percent cap matches the rules established by Freddie Mac and Fannie Mae for conventional loan cash-out refinancing.
Cash-out refinancing has become increasingly popular in recent years as home values have increased and mortgage rates have remained historically low. Between 2013 and 2018, the number of FHA cash-out refinances has increased by 250 percent. In fall 2018, 64 percent of all FHA refinances were cash-out refinances, up nearly 39 percent from fall 2017.
FHA Commissioner Brian Montgomery said in a statement that the reduction in the amount borrowers can take from their homes in a cash-out refinance is meant to be “a prudent measure to make certain that we protect and preserve the home equity borrowers are building for their future and guard against taxpayer losses from the FHA program.”
Low home equity can be problematic for borrowers if home values drop as they did during the housing crisis because this limits the ability of these homeowners to refinance or to sell their property and repay the loan.