The VA loan is a program for veterans of the military. It helps these veterans purchase a home with no down payment and easy guidelines. The VA program also has several other options once you secure a VA loan including a home equity refinance. If you want to refinance your VA loan for reasons other than to lower the interest rate, you can typically do so with the VA cash out refinance.
What is the VA Cash-Out Refinance?
The VA Cash Out Refinance works like any other cash-out program. The lender determines the amount you are eligible to receive based on the value of your home and the amount of your outstanding mortgage(s). For example, if you have a first mortgage with an outstanding balance of $150,000 and a home equity loan with a balance of $30,000, your total outstanding mortgage debt equals $180,000. If the appraiser values your home at $250,000, you have room to pay off both mortgages and tap into your equity, if you wish to do so.
How to Qualify for the Home Equity Refinance with the VA
If you decide that you would benefit from refinancing your VA loan and home equity loan into one large VA loan, you have to qualify for the program. This is different from a VA IRRRL, which stands for Interest Rate Reduction Refinance Loan. This program pertains strictly to your first loan and only applies to veterans that stand to lower their interest rate and/or payment. The VA IRRRL program is not able to help you if you have a second mortgage that you want to refinance, even if it is to lower the interest rate.
In order to perform a home equity refinance with the VA, you have to meet the qualification guidelines for the cash-out refinance. These guidelines are as follows:
- You must have a Certificate of Entitlement. This means that you had an Honorable Discharge and that you have the entitlement to a VA loan. As long as the new loan will pay off the existing VA loan, you can reuse your entitlement for the cash out loan.
- You must be able to prove that you have adequate disposable income after you pay all of your debts. These include your mortgage (principal, interest, taxes, and insurance), as well as your other monthly obligations. After you pay those bills, you need to still have money left over for standard living expenses.
- Your credit history should be fair. The VA does not require “good” credit scores; they just want to see a stable credit history with very few late payments in the last year. The credit score does not matter as much as the actual history.
- Your mortgage history for the last 12 months must be on time; this is the exception to the rule regarding your credit history. The VA will not approve a cash out refinance for any borrowers that could not make their first or second mortgage payments on time during the last year.
- You must live in the property both before you refinanced as well as afterward.
How Much can you Borrow?
The biggest question most borrowers have is how much can they borrow for the cash out refinance? Are you restricted to the amount of your first mortgage and the home equity loan? The answer depends on the value of your home. If, like in the above example, you have room to pay off the first and second loan and still have some equity available, you can take the cash out of the home. Most lenders allow you to borrow up to 100% of the value of the property, but that includes any funding fees and other closing fees you wish to roll into the loan.
Every lender differs in the amount of money they allow borrowers to take out of their home. You might find one lender that will allow you to take 100% of the value of your home while another might only allow you to pay off the first mortgage and home equity loan in order to consolidate and lower your payments. The final decision depends on your credit history, debt ratio, and the amount of disposable income you have after the refinance.
You Must Verify your Income
Unlike the VA IRRRL program, you must verify your income for the VA Cash-Out Refinance. Just like you had to do for the original loan, you must provide your 2 most recent paystubs as well as the W-2s from the last two years. If you work on commission, are self-employed or have irregular income, the lender might also ask you to provide the tax returns from the last two years to ensure that you do not have any expenses that they did not know about as this can affect the amount of qualifying income the lender can use for your loan.
The Funding Fee
It is important to note that the VA funding fee for a cash out loan is much higher than any other type of loan. Right now, most cash out loans require a funding fee of 3.15% of the loan amount. If you borrow $200,000, that equals $6,300. If you have the room in your loan, the lender might let you roll the funding fee into the loan, but you still need to pay it off.
Figuring out if it is Worth It
The best way to figure out if you will save money and when your breakeven point will occur with a VA Cash-Out Refinance is to compare the new payment to your old payments. Take your new VA cash out loan payment with and without the funding fee rolled into it and compare it to the first and second mortgage payments combined that you pay now. If you will save money every month, you can see how long it will take you to pay off the funding fee and start saving money. If your payment increases, then it might not be worth the home equity refinance with the VA loan.
It all depends on the factors of your loan. If you take extra cash out of the equity of your home, then your payment will increase. At that point, you need to determine what you will use the money for and if it is a good decision based on the new payment.
Keep in mind that the largest factor the VA focuses on is the amount of money you have left at the end of the month. They base their decisions on this number since they feel that having adequate disposable income helps borrowers make their mortgage payments on time. This could be the reason the VA has the lowest default rate compared to any other loan program. They care about their borrowers and want to make sure the loan program is right for them.