Paying your mortgage down means you may have equity in the home. Sometimes it even happens when your value increases. What do you do with that money? Do you let it sit? Do you take it out? If you have a USDA loan, you don’t have quite as many options as others. If you want to keep the USDA loan, you can only take cash out for limited reasons. We discuss them below.
Fixing Up Your Home
The only reason the USDA allows cash out with a USDA refinance is to fix up a home. Normally, you borrow the money when you purchase the home. Down the road, however, if things come up you can refinance and use your equity to repair or remodel the home.
You can use the cash out for what the USDA calls construction financing. You can borrow up to 100% of the appraised value of the home. The refinance also consists of 2 closings. The first provides you with the funds for the construction. This is temporary financing. The 2nd closing occurs after completion of the construction. This is when the permanent financing takes place.
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The funds you borrow must directly correlate to the cost of fixing up your home. The lender must provide the USDA with any of the following:
- Draw and disbursement ledger
- Canceled checks from expenses you paid
- Proof of closing costs
You can’t receive cash in hand for this cash out closing. Instead, the funds must be designated to the appropriate party. For example, the lender will disburse the funds directly to the contractor upon inspection and approval of the work.
Building a Dwelling on a Site
If you didn’t place a dwelling on a site you bought with USDA financing, you may be able to refinance it. First, however, you must prove you used USDA funds to purchase the land with the intent to build a home on it. You must also prove you can’t build a home with any other type of financing.
Again, you must prove certain things in order to take cash out for this purpose. They include:
- Draw and disbursement lender for contractors
- Cost of the land
- Canceled checks from any out of pocket expenses
- Proof of the closing costs
Specific Refinancing Guidelines
No matter which cash out refinance option you use, you must follow the below guidelines:
- All construction must be completed within 12 months
- All construction plans must be in writing and approved
In addition, you must meet the general guidelines of the USDA loan. We discuss these below.
Meeting USDA Refinance Eligibility
You must meet USDA eligibility guidelines in order to qualify for the USDA refinance. The house already meets the property guidelines. However, you must prove your household income doesn’t exceed the average income for the area. You can use the USDA’s website to determine your eligibility. Just like before, you’ll have to include every adult’s income that lives in your home. You can still take the same allowances, though. This includes:
- $480 for every child younger than 18
- $480 for every child over 18 attending school full-time
- $480 for every disabled person
- $400 for every elderly person over the age of 62
These deductions help you lower your total household income. If your household income exceeds the limits, you may have to choose other financing options, such as FHA financing.
General USDA Guidelines
You must meet the same guidelines you had to meet with your original USDA loan. This means:
- You must be a United States citizen
- Your housing payment must not exceed 29% of your gross monthly income
- Your total monthly debts should not exceed 41% of your gross monthly income
- You must prove consistent income for the last 2 years
- You must have a clean credit history for the last 12 months (no late payments or collections)
- You should have at least a 640 credit score
These are the minimum USDA guidelines. Lenders may have additional requirements. For example, they may not allow a back end debt ratio as high as 41%. Each lender has their own requirements. They fund the loans, the USDA only guarantees them. This gives lenders the ability to add their own rules onto the loan.
The Bottom Line
USDA financing is generally for borrowers who can’t afford other types of mortgage financing. Those who buy a home in a rural area benefit from this option. However, you can take advantage of the option to take cash out if you need to fix up the home. You’ll have to prove the home needs fixing up and get the approval of the USDA. You’ll receive the same benefits, such as low-interest rates and closing costs. You will have 2 closings, but the process is seamless and well worth the effort if you qualify for the program.
