FHA Home Equity Loan: What Are Your Options With Bad Credit?

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If you have an FHA loan and want the ability to access your home equity, you have several different options, but a true FHA-backed home equity loan isn’t one of them, as the Federal Housing Administration only backs first-lien mortgages. We explore and discuss some of the most readily available loan types, including FHA cash-out refinancing, FHA home improvement financing, and home equity loans and lines of credit.

Can You Take Out a Home Equity Loan With an Outstanding FHA Mortgage?

It is possible to take out home equity financing if you have an existing FHA mortgage, though the FHA doesn’t directly make or endorse secondary financing like home equity loans or lines of credit.

The FHA only insures first-lien mortgages on eligible properties—not home equity lines of credit (HELOCs) or other home equity loans. These are considered to be subordinate financing, because they follow behind the first mortgage in the second-lien position. Even though the FHA doesn’t back home equity loans, it won’t prevent you from getting one while you have an FHA first mortgage outstanding.

In order to qualify for a home equity loan or line of credit, you’ll need to meet the following criteria:

  • Have available equity in the property - Most home equity lenders require that you maintain a certain amount of equity in your property (usually 10%), allowing you to borrow up to 90% of the home’s value between your first mortgage and the equity loan.
  • Have an acceptable credit score - Minimum score requirements will vary from lender to lender, but few will accept scores below 580. The best rates and terms are usually only available to borrowers with scores of 720 and above.
  • Demonstrate the ability to repay the loan - Underwriting requirements are determined by individual lenders, but your debt-to-income ratio and available assets and reserves will be used to determine your ability to repay both your first mortgage and the equity loan.
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Home Equity Loans for FHA Borrowers With Bad Credit

There are many options for cashing out equity if you have an existing FHA loan. These include cash-out refinancing, home improvement financing, home equity loans and home equity lines of credit. If you’re looking for the closest thing you can get to a “true FHA home equity loan,” an FHA cash-out refinance may be your best bet, as these allow you to take out your new loan under FHA backing.

Most borrowers will likely find it most economical to undergo a traditional cash-out refinance, as this could potentially eliminate your PMI requirements under the FHA program. However, the alternatives are still great options if current rates aren't in your favor.

FHA Cash-Out Refinance

An FHA cash-out refinance accomplishes the dual purpose of refinancing your existing mortgage and allowing you to receive cash at closing—proceeds from the equity you have in your property. Since FHA loans already allow for up to 85% refinancing, it is worth considering accessing your equity through a cash-out FHA refinance loan, especially if the new interest rate is lower than your current FHA mortgage rate.

You will have to qualify for the new loan amount based on your income, assets and credit just like you did for the initial loan, and you’ll be required to pay the FHA upfront mortgage insurance premium (UFMIP) again. This is equal to 1.75% of your loan amount, so it’s important to factor this cost into your decision.

It’s important to note that if you refinance within three years of taking out the initial loan, you can receive a prorated partial refund of the original UFMIP. These are the typical minimum loan requirements:

  • Credit scores of 580 or greater
  • Debt-to-income ratio of 43% or less
  • Loan-to-value not to exceed 85% (not including the closing costs and financed UFMIP)
  • No derogatory events reporting on credit, including bankruptcy, short sale or foreclosure (especially on a previous FHA loan), within the predetermined acceptable time frames.

HUD/FHA Title 1 Property Improvement Loan

These loans allow for the financing of improvements that substantially “improve the basic livability or utility of the property,” according to HUD.gov. “Property Improvement loans may be used to finance alterations, repairs and improvements for:

  • a home, including a manufactured home, which has been occupied at least 90 days
  • a nonresidential structure that is functional and was completed prior to loan application
  • or to finance the construction of a new exclusively non­residential, and structure.”

The Department of Housing and Urban Development (HUD) insures private lenders against loss on Title 1 home-improvement loans they make. Neither HUD nor the FHA lend funds directly, but you will have to meet the qualifying criteria they set and demonstrate your ability to repay the loan, in affordable monthly payments.

A Title I Property Improvement loan amount is limited to $25,000 for single family homes, and must be for the actual cost of the improvement project, plus any allowable and applicable fees.

FHA 203(k) Loan

FHA 203(k) insured loans enable homebuyers and homeowners to finance both the purchase or refinance of a home and the cost of its rehabilitation through a single, first mortgage. The qualifying criteria for these loans are the same as traditional FHA loans, including proving ability to repay and minimum credit score requirements of 580.

The minimum cost of the rehabilitation is $5,000, but the total loan amount still can’t exceed the FHA loan limit for the area. The valuation of the property, for lending purposes, is the lesser of either the current value of the property plus the cost of improvements, or 110% of the appraised value after rehabilitation.

According to HUD.gov, the allowable types of improvements that borrowers may make using FHA 203(k) financing include:

  • structural alterations and reconstruction
  • modernization and improvements to the home's function
  • elimination of health and safety hazards
  • changes that improve appearance and eliminate obsolescence
  • reconditioning or replacing plumbing; installing a well and/or septic system
  • adding or replacing roofing, gutters and downspouts
  • adding or replacing floors and/or floor treatments
  • major landscape work and site improvements
  • enhancing accessibility for a disabled person
  • making energy conservation improvements

The program doesn’t allow for luxury improvements such as a new swimming pool or tennis court.

High-LTV Home Equity Lenders

FHA loans allow for up to 96.5% purchase financing, so it’s important to understand how much equity you have available. Unless your home has appreciated in value significantly, or you’ve had enough time to build up your equity through monthly payments, you may need a home equity lender who offers higher loan-to-value (LTV) loans.

High-LTV lenders do exist, and the list includes specialty credit unions, banks and direct lenders. This include but are not limited to the following lenders:

Navy Federal Credit Union offers home equity loans with:

  • Ability to borrow up to 100% of your home's equity.
  • Loan amounts from $10,000 to $500,000.
  • Fixed or variable interest rates.
  • No application or origination fees.
  • Interest-only options.
  • Terms of 5, 10, 15 or 20 years.

Pentagon Federal Credit Union offers home equity loans with:

  • Ability to borrow up to 90% of your home’s equity.
  • Loan amounts from $10,000 to $400,000 - Maximum loan amount is $250K for 85.01% to 90% loan-to-value.
  • Fixed or variable interest rates.
  • Interest-only options.
  • Terms of 5, 10, 15 or 20 years.

When shopping for a home equity lender, it’s important to consider the costs of financing as well as the overall equity position you have in your home. It’s possible to become overleveraged—owing more than your home is worth—if property values decrease over time. In this case, you’re still responsible for repaying your loans, regardless of the current property value, so tread carefully.

Comments and Questions

Editorial Note: The editorial content on this page is not provided or commissioned by any financial institution. Any opinions, analyses, reviews, statements or recommendations expressed in this article are those of the author alone, and may not have been reviewed, approved or otherwise endorsed by any of these entities prior to publication.

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Get Multiple Home Equity Offers at Once
Get Multiple Home Equity Offers at Once
LendingTree can help you find and compare home equity rates, all without affecting your credit.
LendingTree is our ultimate parent company
See Offers

on LendingTree's secure website. NMLS #1136: terms and conditions apply

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LendingTree is our ultimate parent company