There are two primary mortgage options when it comes to refinancing your VA home loan. There is the VA IRRRL loan and the VA cash out refinance loan. Have you ever wondered how you can access the equity of your home if you financed using your VA home loan benefit? If so, you’re in the right place! The VA allows you to apply for a VA cash-out refinance loan. This loan essentially replaces your existing VA loan with a brand new one, and allows you to draw cash out of the loan at closing. Not only can you get money for home improvements, it could potentially lower the interest rate on your current loan. You can even refinance a conventional mortgage into a VA cash out loan. It sounds good, right? Of course, but there are always questions you should ask yourself before making a decision to refinance your current mortgage.
VA Cash Out Refinance Guidelines
First off, let’s go over the basics of a VA cash out refinance. Say you have some major home expenses come up, like a roof repair, a broken furnace, or a deck that needs replacing. You have two options to consider when tapping into your equity for help tackling these repairs. One is a Home Equity Loan, and one is a Cash Out Refinance.
A home equity loan, also known as a HELOC (Home Equity Line of Credit) functions as a second mortgage. It’s an additional loan that exists beside your current mortgage, using your home equity as collateral. Say your home appraises at $300,000, and your current mortgage balance is only $175,000. A bank may extend you a $75,000 line of credit that you can use on an as-needed basis. As soon as you use any of it, you will have a monthly payment in addition to your mortgage. The interest rate is usually variable as well, so your payments will go up and down based on market conditions.
On the other hand, a cash out refinance means you replace your current mortgage with a new one that is for more than your existing loan. When you close on the loan, you would get the difference in cash. This is not an additional loan like the HELOC. It’s a new mortgage with a brand new, higher balance. Working with the example we used above, your home appraises for $300,000 and your current mortgage balance is $175,000. You are looking to take out $75,000 in equity to repair the roof, fix the furnace and replace your deck. You go through the loan process based on a total new mortgage of $250,000 plus closing fees. At the closing, the lender will provide you with a check for $75,000 to use however you see fit.
With a conventional mortgage, lenders will require borrowers to maintain at least 20% equity in the home after any cash out refi. So if your home appraises for $300,000, the highest loan balance a lender will allow is $240,000. This does not hold true for you – because you are eligible for a VA cash out refinance. You have the backing of the Veteran’s Administration on your side. Using that $300,000 example, your total loan balance at the end of closing can total $300,000. You get the benefit of being able to withdraw more cash than others not eligible for the VA loan benefit.
Cash Out Refinance Pros and Cons
There are always pros and cons when considering a cash out refinance. You’ll need to look at both sides very carefully. It can be a really good option if you deem the circumstances are worth eating into the equity of your house. Here are some of the advantages of cashing out some of your equity:
· Interest rates may have fallen since you got your first mortgage. This is usually the catalyst for most people to begin looking into refinancing. By lowering your interest rate, you may be able to take out the cash you need while keeping your payments close to their current level.
· It can be a good way to get a large sum of money at a low interest rate. Many home repairs and improvements can be very expensive. Not many of us have an extra $50,000 laying around to
use, as much as we may aspire to. Taking the money out of your equity can be much less expensive than putting costly home repairs on a credit card or taking out a personal loan.
· If you use your cash for improvements to the house, the interest on the cash out portion of the loan is tax deductible. If you refinance your $175,000 mortgage and cash out that $75,000 to use on home improvements, not only is the interest on the original $175,000 tax deductible, the interest on the additional $75,000 is also tax deductible. This is not the case if you use the cash for other purposes, such as debt reduction. In that case, only the interest on the original $175,000 is tax deductible.
Disadvantages you may want to consider:
· If interest rates have gone up since you financed your home, you will be refinancing at a higher interest rate. This is going to be a big factor in whether you decide it’s worth taking out the cash. Not only will your payment potentially go way up, the cost of the loan will be much more expensive.
· You may be dragging out the repayment of your house. As you make your monthly mortgage payments, your equity naturally increases as your principal balance goes down. At the time of refinancing, you may be 15 years into your 30-year loan. If you refinance for a lower interest rate and take cash out on top, you start over at the beginning of the loan term. Instead of having your home paid off by the time you’re 60, you’ll be paying your mortgage until the age of 75.
· You run the risk of giving into the temptation to use your house as an easy source of cash. Especially with your military status allowing you to cash out up to 100% of your home’s value. You may be tempted to use the money on luxury items that are not financially sound reasons to tap into your home’s equity. You can easily over-extend yourself financially, increasing the risk of losing your home if the unforeseen happens.
Deciding whether or not to access your equity for cash is a very personal decision. One nice thing about cash out refi’s is that there aren’t any limitations on how you can use the money. Technically you can use it for anything. But in general, since you are borrowing against one of your basic human rights (shelter), it only makes sense to use the proceeds to put yourself in a better financial situation. What are the most popular reasons people decide to move ahead? The big three are home repairs and improvements, education costs and debt reduction.
Home Repairs and Improvements are probably the easiest thing to justify using equity to pay for. The money you are taking out is going right back into the home, which may increase the overall value of the house. You could renovate a bathroom or kitchen, upgrade or add a porch or deck, replace a leaking roof, or exchange your old heating system for a more energy efficient model. You may want to upgrade old appliances to new, energy efficient models as well. All of these have the potential of adding value to your home as well as saving you money on monthly expenses.
Education is another reason you may consider tapping into your home equity. If you want to help your child pay for college, VA refinance rates may be much lower than student loan rates, and many parents feel this is a better option than leaving their child paying student debt for years to come.
Paying off high-interest debt is another way many people use money they get from a cash out refinance. This is a hot button topic among financial analysts and advisors. Some are for it, and others think it’s a downright bad idea. Credit cards and personal loans are usually very high interest. If you have a high
amount of debt, using the equity from your home could save you years and thousands of dollars in interest. It also allows you to stretch the payments out over the 30-year term, easing the monthly financial burden and increasing your cash flow. It may even raise your credit score, if it’s currently low due to high credit usage ratios. If you are thinking of using equity to pay off credit cards, or high-interest personal loans, keep the following things in mind:
· You are using your home as collateral to pay off currently unsecured debt. Defaulting on a credit card is much different than defaulting on your mortgage. You may not want to risk putting yourself and your family out on the street to pay off the high-interest debt.
· Once your cards are paid off, you will need to be diligent about not running up balances again. You’ve already potentially increased your mortgage payment to cover the credit card balances, if you run up more debt on top of that, you risk not being able to meet your monthly expenses.
· You’ve eaten into the equity of your house to pay off the debt. That means the equity is no longer there if you do run into major home repairs.
VA Cash Out Refinance Process
When you decide that a VA cash out refinance is right for you, what is the process? As it was for your original loan, you will have to meet all requirements and guidelines set forth by the VA, and also go through the underwriting process again with a private lender. It’s also a good thing to visit a few different lenders. Cash out refinance rates can vary from lender to lender, and some lenders may have different minimum guidelines for underwriting purposes and regulations surrounding the loan. But in general, you can expect:
· Lenders often require a minimum credit score of 620. Some lenders may even go as low as 580. But to be safe, a credit score of 620 or more is preferred.
· You will need to establish a stable income that meets all residual income and debt-to-income requirements set forth by the VA and the lender. Typically, a lender will want your DTI to be no more than 41%.
· The closing costs for a cash out refinance cannot be rolled into the mortgage, however the VA funding fee can. You may be able to use the cash from the refi to pay closing costs. Check with your lender to see if this is allowed.
· You must be able to certify that you will be the primary resident of the house being refinanced. You are not able to do a cash out refi on a rental property.
· It is possible for a house to fall into disrepair rather quickly, so a lender will require a new VA appraisal to verify your home’s current fair market value.
· You will need your Certificate of Eligibility to prove to the lender that you qualify for a VA home loan. COE’s do not expire, and your current lender may still have yours on file. Be sure to ask!
If you live in Texas, you will want to pay special attention to this paragraph. The state of Texas has very stringent home equity laws that restrict all cash out refinancing to 80% of the loan value. This law will override any VA benefit you may otherwise be entitled to. You still are able to get a VA cash out loan and take advantage of the low interest rates and relaxed underwriting guidelines. The loan will also still be guaranteed by the VA. But in order to qualify in Texas, the total amount of the loan after refinance must leave you with 20% equity remaining in your home
VA Streamline Refinance Option
The VA cash out is a wonderful option for veterans however it’s not for everyone. There are other VA refinance options available, especially if you don’t need to take any cash out of the home. If you are looking to lower your interest rate, and possibly your payment, the VA IRRRL program is a fantastic option. Like with any loan there are IRRRL program pros and cons to consider.
VA IRRRL stands for VA Interest Rate Reduction Refinance Loan. This loan is also called a VA Streamline loan because the process is designed to be quick and easy. You can generally apply and close in under 30 days, whereas a cash-out refinance can take upwards of 45 – 60 days. It’s designed to be fast because you aren’t taking any additional cash out. The VA uses the information given during the original loan application process. You already have your Certificate of Eligibility, had your credit checked and the VA home appraisal is completed. The lenders re-use all that information, which saves a ton of time. You can read more about the VA IRRRL loans HERE [link to other blog article].
If you would like more information on applying for either a cash out refinance or an IRRRL, National VA Loans is here to help. Whichever refinance you choose, we can walk you through the process step by step. Just call us at 855-956-4040 to speak to one of our specialists. Thanks for reading!