How to Refinance a VA Loan

VA home loans represent one of the most outstanding benefits available to veterans.  And, with interest rates at historic lows, many veterans would like to refinance their existing mortgages. As such, we’ll use this article to explain how to refinance a VA loan.

Specifically, we’ll discuss the following:

• VA Loan Overview
• VA Loan Refinance Option 1: IRRRL
• VA Loan Refinance Option 2: Cash-out Refinance
• VA Loan Refinance Option 3: Conventional Loan
• Additional Refinancing Considerations
• Final Thoughts

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VA Loan Overview

Prior to explaining how to refinance a VA loan, here’s a brief overview of the loan program itself.  While the Department of Veterans Affairs guarantees these loans, it doesn’t actually act as a lender. In other words, when you apply for a VA loan, you don’t borrow money directly from the VA.

Instead, the VA protects approved lenders (e.g. banks, credit unions, etc.) in case a borrower defaults on a VA loan. When a borrower stops making payments, the VA will pay the lender a certain amount of the outstanding loan balance. This VA guarantee lowers risk for lenders, and the lenders pass this lowered risk on to qualified veteran borrowers. More precisely, this VA guarantee enables the following great borrowing terms:

• No down payment required
• Low interest rates
• No private mortgage insurance (PMI) required

These outstanding characteristics lead many veterans to use the VA when purchasing their first homes. And, when interest rates drop, these same veterans often look for opportunities to refinance their VA loans. We’ll discuss three options to do this in the below sections.

VA Loan Refinance Option 1: IRRRL

If you currently have a VA mortgage, one of the most popular – and easiest – refinancing options is the VA’s Interest Rate Reduction Refinance Loan (IRRRL). While the name may be a bit of a mouthful, the program itself offers incredible refinancing options to veterans.

Sometimes referred to as a “streamline” refinance, the IRRRL can help borrowers:

• Lower monthly payments by reducing your mortgage’s interest rate; or
• Make your payments more stable by converting from an adjustable or variable rate mortgage to a fixed rate one.

Additionally, for anyone who has closed on a mortgage, you know how difficult a process it can be – seems as if the lender always needs just a little more information. The “streamline” nature of the IRRRL means that the actual qualification requirements (e.g. income, credit score, debt-to-income, etc.) are less arduous. Bottom line, the VA wants to make this an easy path for veterans to reduce their monthly VA loan payments.

To refinance your VA loan with an IRRRL, you’ll need to meet all of the following requirements:

• You already have a VA loan on the property you’re refinancing
• You’re using the IRRRL to refinance this existing VA loan
• You can certify that you currently live in – or used to live in – the home you’ll be refinancing

VA Loan Refinance Option 2: Cash-out Refinance

With this option, you refinance a VA or conventional loan and take cash out with the new VA loan. Here’s how the cash-out concept works:

If you’ve had a mortgage for several years, every payment you made reduced the total loan balance. When your home’s value is greater than the loan on that home, you have equity – or ownership – in the property. And, a cash-out refinance loan lets you actually access that equity as cash.

For example, assume you own a house that has an appraised value of $200,000. If your current outstanding mortgage balance is $150,000, you have $50,000 of equity in the house ($200,000 – $150,000 = $50,000). Depending on the loan terms, a cash-out refinance would let you pay off your old mortgage, take out a new, larger loan, and pocket the difference between the two as cash. In this example, if you refinanced into a new $175,000 loan, you would receive $25,000 in cash, minus closing costs ($175,000 new loan – $150,000 old loan = $25,000 cash).

The VA recognizes that many veterans want to conduct this sort of cash-out refinance, and a VA cash-out refinance loan option exists. With this loan, the home you’re refinancing must be your primary residence. Furthermore, lenders will require a minimum credit score and a VA appraisal.

To confirm if you’re eligible for a VA loan cash-out refinance, you or your lender must first request a Certificate of Eligibility (COE) from the VA. If eligible, you can either:

• Refinance an existing VA loan; or
• Refinance a conventional loan into a VA loan.

NOTE: This VA loan cash-out refinance is the only path available to convert a conventional loan into a VA loan.

Depending on your specific lender’s requirements, you may have the ability to refinance up to 100% of your home’s appraised value. Continuing the above example, that means you could potentially refinance into a new, $200,000 mortgage and take $50,000 out in cash. However, with these loans, borrowers need to pay closing costs up front, but you can use the cash from the refinance to cover these costs.

VA Loan Refinance Option 3: Conventional Loan

The above two options entail refinancing into a new VA loan. However, in some situations, borrowers may choose to refinance out of a VA loan. In other words, if you currently have a VA loan on a home, you may want to refinance the existing VA loan into a new, conventional loan.

Two primary reasons exist to pursue this refinancing strategy:

• Rental property conversion: You cannot use the VA loan to purchase pure investment properties. But, you can (with certain restrictions) refinance your current home’s VA loan into a conventional loan, convert that property into a rental, and use a VA loan to purchase a new, primary residence.
• Better conventional terms: While VA loans typically offer outstanding terms, you may be able to find better terms with a conventional loan product, especially if you’ve built up significant equity in your home. In these situations, refinancing from a VA loan to a conventional loan could make sense.

No single refinance product exists for this strategy. Rather, borrowers considering refinancing out of the VA loan program into a conventional loan will need to research different options for their unique situations.

Additional Refinancing Considerations

Before refinancing a VA loan, borrowers should consider a couple additional factors.

First, when you conduct a cash-out refinance, you inherently take a larger loan than your current one. As such, you’ll likely A) extend your repayment period, and B) increase your total interest payments over the life of the loan. These additional costs may be outweighed by the benefits of getting cash now, but they should still be considered.

Next, when using the VA’s IRRRL or cash-out refinance programs, you’ll need to pay a VA funding fee. Some service-disabled veterans and surviving spouses do not need to make these payments, but fees for most veterans entail:

• IRRRL funding fee: 0.5% of the total loan amount
• VA cash-out refinance: 2.3% of total loan if it’s your first VA loan, and 3.6% for subsequent VA loans

Final Thoughts

VA home loans are one of the most outstanding financial benefits available to veterans. And, they can absolutely be the “gift that keeps on giving.” A VA loan can get you into a home, and refinancing a VA loan can A) make it more affordable, or B) give you some extra cash in your pocket.

Maurice “Chipp” Naylon spent nine years as an infantry officer in the Marine Corps. He is currently a licensed CPA specializing in real estate development and accounting.

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