Looking to shave some money off your monthly mortgage payment? Refinancing your existing mortgage loan to a loan with a lower interest rate can help reduce your mortgage payment by hundreds of dollars a month in some cases. If you are an active member of the U.S. Military or a veteran of the armed forces, you have an even better option. You can refinance to a VA loan, which might come with even lower interest rates.
The option of a VA loan also gives you the chance to tap into your home’s equity to receive a lump sum of cash that you can use to consolidate debts, go back to school, pay off student loans or anything else you may need to tackle.
The good news? Refinancing your existing mortgage to a VA loan isn’t overly complicated. You just need to know how these types of refinances work and who’s eligible to take advantage of them.
What is a VA loan?
A VA loan is a mortgage loan that’s insured by the U.S. Department of Veterans Affairs. The goal of these loans is to help military service members, veterans and surviving spouses of military members become homeowners.
Using a VA loan to purchase a home is an attractive move because VA loans don’t require a down payment. This makes it easier for borrowers who are short on cash to buy a home.
The Department of Veterans Affairs also offers two types of refinance loans, the Interest Rate Reduction Refinance Loan, or IRRRL, and the VA-backed cash-out refinance loan.
The IRRRL is the more limited of the two options. You must already have a VA loan to refinance to the Interest Rate Reduction Refinance Loan. If you have any other type of mortgage – including an FHA loan or conventional mortgage loan not insured by any government agency – you can’t refinance into an IRRRL.
The VA-backed cash-out refinance loan, on the other hand, is different. You can refinance any type of loan, including a standard conventional mortgage, into this type of loan. When you do, you can also refinance your loan for 100% of your home’s appraised value. This is important because if you have equity in your home, you can tap it in the form of cash when your refinance closes. You can then use that money to pay for anything you’d like, from a major kitchen renovation to your children’s college tuition.
Equity is the difference between what you owe on your mortgage and your home’s current value. Say you owe $130,000 on your mortgage and your home is worth $200,000. You have $70,000 in equity. You can refinance your existing mortgage to a VA-backed cash-out refinance loan of $200,000. You’d then receive that $70,000 in equity as a single payment. You can spend that payment however you’d like.
Remember, though, that if you do this, your new loan will be for a higher amount due to the cash-out portion of the refinance. In the above example, you will be paying back $200,000 in monthly installments with interest instead of $130,000.
Though the name suggests it, you aren’t required to take out cash with the cash-out refinance option. You can also refinance for whatever you owe on your mortgage, leaving your equity untouched.
Why would you refinance to a VA loan?
The main benefit of refinancing to an IRRRL or VA-backed cash-out refinance loan is to nab a lower interest rate, which will reduce your monthly payment.
Say you are paying off a $200,000 loan with a 30-year term and a fixed interest rate of 5%. Your monthly payment would be $1,548, not counting anything you’d pay to cover property taxes and homeowners insurance.
Now let’s say you’ve paid this loan down to $150,000. If you refinance your current mortgage into a $150,000 30-year, fixed-rate IRRRL or VA-backed cash-out refinance loan with a lower interest rate of 3%, your monthly payment, not including property taxes or homeowners insurance, would drop to $1,010.
Or, let’s say you choose the VA-backed cash-out refinance option and refinance to a 30-year, fixed-rate loan for $200,000 at 3% interest to take advantage of the cash-out feature. Your monthly payment, not including taxes and insurance, would still drop, this time from $1,548 to $1,318.
You might also choose to refinance to a VA loan if you are currently paying back an adjustable-rate mortgage. With these mortgages, interest rates start low and remain fixed for a certain number of years, usually five to seven. But once these loans enter their adjustable period, their rates fluctuate, often once every year.
Depending on the economic index to which these loans are tied, the rate can rise, causing homeowners’ monthly payments to increase. If you have an adjustable-rate mortgage, you might want to refinance to a VA loan with a fixed rate to avoid the uncertainty that comes with fluctuating interest rates.
Who is eligible for a VA refinance?
VA loans are restrictive. You can qualify for one of these loans if you are an active-duty member of the U.S. military or a veteran of the armed forces. You may also qualify if you are a member or veteran of the reserves, Coast Guard or National Guard — or if you are an officer at the National Oceanic & Atmospheric Administration.
The surviving spouses of military veterans may also qualify for a VA loan if they are not remarried. These spouses can also qualify for these loans if their spouses died of a disability related to their service time.
To qualify for an IRRRL, you must already be paying off an existing VA loan. You’ll also need to show your Certificate of Eligibility, or COE, from your original VA loan. The COE is a document proving that you meet the eligibility requirements of a VA loan. You can ask your lender to access a database to obtain your COE on your behalf when you apply for a loan.
To qualify for a VA-backed cash-out refinance, you again must provide a COE to your lender. You’ll also need to provide copies of documents that prove you can afford your new monthly payments. This includes copies of your most recent pay stubs, W-2 forms, bank account statements and federal tax returns.
What are VA loan funding fees?
No refinance is free. You’ll always have to pay closing costs, the fees that lenders charge for completing your refinance. You can either pay these upfront or roll them into your mortgage, meaning you’ll pay them back as you make your monthly payments.
VA loans also charge a funding fee. Again, you can pay this fee upfront when you close your VA refinance or you can roll it into your new loan, slightly increasing your monthly payment.
For 2020, the funding fee for an IRRRL is 0.5% of the loan amount. If your IRRRL is $150,000, your funding fee would be $750. The funding fee in 2020 for a VA-backed cash-out refinance is 2.30% of your loan amount if this is your first VA-backed refinance, and 3.60% if it is your second time or more refinancing to this type of loan.
If your VA-backed cash-out refinance loan is $150,000, you’ll be charged a funding fee of $3,450 if this is your first time using this benefit. You can pay that $3,450 upfront or you can add it to your loan amount and pay it back over time with your monthly payments.
How to refinance to a VA loan
Refinancing to a VA loan will require different steps depending on the type of loan you are now paying off.
You can only refinance to an IRRRL if you already have a VA loan. If you can take advantage of this option, you’ll find that the process is simple.
First, you’ll need to work with a private lender. VA loans are insured by the U.S. Department of Veterans Affairs, but they are originated by private lenders. Fortunately, finding a lender to originate a VA loan is not difficult. Most lenders across the country handle VA loans.
Once you find a lender, you’ll need to provide that lender with your Certificate of Eligibility, the document proving that you meet the requirements for a VA loan. Your lender can pull this document for you.
One of the benefits of an IRRRL refinance is that you are not required to go through the underwriting process. This means that depending on your lender, you might not have to provide any documents verifying your finances or debts.
Your lender also won’t require that your home be appraised. In most refinances, an appraiser must determine the current value of your home. This step isn’t necessary in an IRRRL refinance. This will save you money – appraisals can cost $500 or more – and time.
An IRRRL refinance isn’t free, though. Lenders will charge you closing costs that depending on your lender and loan amount can run $3,500 or more. You can either pay these upfront or you can add them to your new loan amount. You’ll then pay your closing costs back over time with your monthly payments. You won’t have to come up with a large amount of cash at closing, but your total mortgage amount will be slightly higher, depending on how much your closing costs run.
If you currently have any other type of mortgage – including FHA, VA and conventional – your only option for refinancing to a VA loan is through the VA-backed cash-out refinance loan.
Again, you’ll work with a private lender that can originate VA loans. You can’t skip the underwriting process during this type of refinance. Your lender will check your credit. You’ll also provide copies of your most recent paycheck stubs, W-2 forms, bank account statements and federal tax returns.
Your lender will send an appraiser to determine the current value of your home. Your home will need to be worth at least as much as the amount of money you are borrowing.
As with an IRRRL, you’ll need to provide your lender with your Certificate of Eligibility to make sure you are eligible for a VA-backed cash-out refinance.