If you’re a veteran or active military with a VA-backed mortgage, there are two ways to take advantage of historically low refinance rates: by taking out an Interest Rate Reduction Refinance Loan (IRRRL) or by taking out a cash-out refinance loan. Each has their pros and cons, but both of them can earn you serious monthly savings if you qualify for a good interest rate.
Refinancing Your VA-Backed Mortgage
- What Is a VA Mortgage Refinance?
- When Is a VA Mortgage Refinance Worth It?
- Interest Rate Reduction Refinance Loan
- VA-Backed, Cash-Out Refinance
- Next Steps
What Is a VA Mortgage Refinance?
Like any home loan, mortgages backed by the U.S. Department of Veterans Affairs (VA) can be refinanced to get better loan terms—including a lower interest rate, which means cheaper monthly payments and money saved in the long run.
“Interest rates are at an all-time low. “If you already have a VA loan and the math makes sense, it’s very advantageous to refinance,” says Mark Reyes, CFP, financial advice expert at Albert, an automated money management and investing app. Reyes points to the current interest rates (as of November 24, 2020) ranging from 2.5% to 3% for 15- and 30-year fixed-rate mortgages.
When Is a VA Mortgage Refinance Worth It?
Before refinancing a VA-backed mortgage, you should consider when it’s worth it to do so.
One instance when it might make sense for you to consider this option is if you have strong credit. In general, lenders offer more favorable refinance rates to those with a steady income, a history of responsible credit use, and a low debt-to-income ratio. So if you have a strong credit profile and can secure low rates, this can be a worthwhile option for you.
Another thing to consider: Think about how long you plan on staying in your home. “Let’s say I knew I was getting a permanent change of station to another location,” says Eric Bronnenkant, head of tax at Betterment, a robo-advisor and online bank, and a veteran himself. “That may be a counterargument for doing it. If you know with some relative certainty that you’re going to be effectively forced to move, then it might not make as much economic sense [to refinance your home].”
What is an Interest Rate Reduction Refinance Loan (IRRRL)?
One refinance option, if you have a VA-backed loan, is an Interest Rate Reduction Refinance Loan (IRRRL). Also known as a streamline refinance, an IRRRL allows you to refinance your VA-backed mortgage to get a potentially lower interest rate or switch from an adjustable rate to a fixed rate. Although an IRRRL is backed by the VA, you’d get the loan from a bank, credit union, or other lender.
What Are the Benefits of a VA IRRRL Refinance?
With an IRRRL — or any other VA loan — you won’t have to pay private mortgage insurance (PMI), which is typically between $30 to $70 per month for every $100,000 on the mortgage, according to Freddie Mac. Most conventional lenders require you to pay PMI if you make a down payment that’s less than 20% of the home’s value.
Another perk of an IRRRL is that you won’t have to provide much documentation. “Unlike a cash-out refinance, the standards for documentation are much lower for an IRRRL,” says Bronnenkant. Typically, lenders will need you to provide documents to prove the income, assets, and debt you self-report on the application, in order to verify your creditworthiness. With an IRRRL, the burden of proof is much lower, and therefore the application process is simpler.
Another upside? Unlike most refinancing options (including the VA-backed cash-out refinance), you won’t need to go through an appraisal or pay an appraisal fee either.
What Are Some Disadvantages of an IRRRL?
One downside of an IRRRL is the 0.5% VA funding fee, which can either be paid upfront or rolled into monthly payments. And, like any other refinance, there are closing costs associated with the lender, which can add surprise expenses if you don’t do the math beforehand.
Who is Eligible for an IRRRL?
You have to meet the following qualifications for an IRRRL:
- You have a VA-backed mortgage. The IRRRL program is only for people served by the VA, and that includes veterans, service members, surviving spouses, the National Guard, Reserves, and anyone who’d qualify for a Certificate of Eligibility (COE).
- You’ll use the IRRRL to refinance the VA-backed mortgage, and not any other home loan.
- You can offer proof that you currently live or have previously lived in the home with the VA-backed mortgage. If the property has only ever been for investment purposes, then you won’t qualify for an IRRRL.
What Are the Costs of an IRRRL?
One way the government is able to help back this mortgage is through the VA funding fee, which is a one-time cost you pay either upfront or each month (with interest) when rolled into the term of the loan. For an IRRRL, this fee is 0.5% of the mortgage’s remaining principal. Unless you have a service-connected disability or are the surviving spouse of someone who died in service (with a few other exemptions), nearly everyone seeking an IRRRL will be required to pay the VA funding fee. You’ll also have to pay whatever closing costs are associated with the lender, and that will typically be 2% to 5% of the remaining principal.
The fee may seem like a roadblock, but the numbers could work out in your favor if you secure a significantly lower interest rate. “If you’re getting a rate reduction that is sizable, you may recover that 0.5% pretty fast,” Bronnenkant says. You’ll also avoid paying PMI, which is normally for most people when they put less than 20% down on a home with a conventional mortgage.
What is a VA-Backed Cash-Out Refinance Loan?
A VA-backed, cash-out refinance allows you to refinance a current mortgage and draw upon your home equity for cash. With this option, you replace your existing mortgage with a new mortgage that’s larger than what you currently owe, and you receive the difference as cash to spend.
This is beneficial for people who want to refinance a non-VA conventional loan into a VA-backed loan, as well as for people who would like to use the cash to pay off debt, fund home projects, finance their education, or for another purpose. You can refinance up to 100% of the home’s appraised value. However, banks consider this a riskier investment and will likely charge you a higher interest rate than what you previously had.
What are the Benefits of a VA-Backed Cash-Out Refinance?
Unlike an IRRRL, you can use this program if you don’t already have a VA-backed mortgage — as long as you meet the eligibility criteria. A benefit of a VA-backed loan, as opposed to a conventional refinance, is that you don’t have to pay for expensive mortgage insurance.
With a cash-out refinance, you also have the freedom to use the cash from your home’s equity for whatever your needs are. You could, for example, help fund college tuition or a home renovation or consolidate other debt. This is a risky move, though, because if you’re unable to make payments, you could default on your home and lose it.
What Are Some Disadvantages of a VA-Backed Cash-Out Refinance?
The interest rate that comes with a cash-out refinance is often higher because banks consider this type of refinance riskier than alternate refinancing options. So if you’re looking to secure a lower rate with a refinance, this may not be the option for you.
Another drawback: You’ll have to pay the VA funding fee (2.3% for the first use, then 3.6% after) either upfront or using the cash withdrawn from the equity of your home. And this refinance option also has more stringent approval standards; you’d have to meet a minimum credit requirement from the lender and go through a credit underwriting and appraisal process. The home you’re refinancing must also be your primary residence, and not a vacation home or investment property.
In terms of documentation, the VA specifies that you’ll need to provide copies of paystubs for the most recent 30-day period, as well as W-2 forms and copies of your federal income tax returns for the past two years, in order for the lender to verify your creditworthiness.
Who is Eligible for a VA-Backed Cash-Out Refinance?
You can qualify for a VA-backed cash-out refinance if you meet the following criteria:
- You qualify for a Certificate of Eligibility (COE). The VA website details what the minimum active-duty periods are for whatever time period you were or have been in the military, National Guard, or Reserve.
- You meet the standards for credit, employment, and other requirements from the VA and the lender.
- You’ll live in the home you’re refinancing with the loan. Unlike with an IRRRL, it’s not enough to have lived in the home in the past. You must currently live there.
What are the Costs of a VA-Backed Cash-Out Refinance?
With a cash-out refinance, you will have to pay the VA funding fee as security for this government-backed loan. As of November 24, 2020, the fee is 2.3% for first use (of the refinance program), and then 3.6% after the first use. Unlike the IRRRL, which gives you the option of rolling the fee into your monthly payments, the fee associated with a cash-out refinance must be paid upfront or with cash you take out.
Most people will have to pay the VA funding fee, but there are exemptions, like if you have a service-connected disability, have received the Purple Heart, or are the surviving spouse of someone who died in service. The full list of exemptions can be found on the VA website. You’re also responsible for any closing costs associated with the refinance (typically between 2% and 5% of remaining principal, depending on the lender).
1. Browse Lenders
Many people tend to go with the bank servicing their current mortgage through. And while it may be the most convenient option, it doesn’t necessarily translate to the most savings. “You can shop around and you should shop around,” Bronnenkant says. Take a look at other banks, credit unions, brokers, and lenders, and apply for pre-approvals to see what kind of refinance rate and loan terms you’d qualify for. You can apply for an IRRRL or a conventional refinance at various lenders and compare the offers you receive.
2. Apply for Refinancing
Once you’ve found a lender you’re interested in — or better yet, once you’ve received a promising pre-approval offer — you’re off to the big leagues. Officially applying for a refinancing loan will likely require you to offer the following details and more:
- Full name
- Date of birth
- Proof of income
- Employment status
- Existing assets and debt
- The home’s mortgage terms
- Proof of homeowners insurance
- Social Security number.
After you’ve applied, the lender will run a hard credit inquiry on you. This allows the lender to evaluate your credit history and how likely you’d be able to pay back the loan.
3. Provide Documentation Upon Approval
If you’ve been approved by the lender, you’ll need to share documents with the lender to verify the information you provided during the application process. You’ll likely need to provide pay stubs, tax documents like W-2s, proof of homeowners insurance, documentation of debt and assets, copy of title insurance, and a Certificate of Eligibility proving you qualify for a VA-backed refinance. But remember: With an IRRRL, though, fewer documents are required than if you went with a cash-out refinance.
4. Close on the Refinancing Process
The closing costs required will depend on the lender you choose, but they often encompass appraisal and inspection fees (applicable to cash-out refinancing), attorney’s fees, and origination fees. It’s common for closing costs to represent between 2% and 5% of the outstanding principal, so make sure to factor these, plus interest on the loan, into your budget.
If you’ve chosen to refinance with an IRRRL, you’ll also decide whether to pay the 0.5% VA funding fee upfront or roll it into the loan’s monthly payments. Reyes recommends paying upfront if you can afford it, as you would otherwise be paying interest on that fee every month.