Once you buy your home and start gaining equity in it, you may be able to take that equity out if you need it. Just because it’s available, it doesn’t mean it always makes sense to do so. Before you use the opportunity to use the VA cash out refinance loan, learn the top reasons you may want to reconsider.
You’ll Pay Closing Costs
Anytime you take out a new mortgage, you pay closing costs. The only exception to the rule is if you negotiate a no-closing-cost loan with the lender. Sometimes lenders are willing to cover your closing costs in exchange for a higher interest rate. In the case of the cash-out refinance, though, this usually isn’t an option. Lenders are already taking a higher risk by giving you a larger loan.
The closing costs on a cash-out loan can cost as much as 5% of the loan amount. Of course, this varies by lender. It also depends on your qualifying factors. The lower risk you pose to the lender, the fewer closing costs they will charge you. Specifically, you may pay lower origination fees or discount points.
The fact that it costs anything to get access to your money though, is definitely a downside to using the cash-out refinance.
You’ll Pay a Funding Fee
Do you remember when you took out your original VA loan and you had to pay either 2.15% or 2.4% of the loan amount, depending on your type of military service? You will have to pay that fee all over again if you tap into your home’s equity.
Unlike with the VA Interest Rate Reduction Refinance Loan, where you pay a discounted funding fee, you will pay the same 2.15% or 2.4% for the cash-out loan. On a $250,000 loan, that means $5,375 paid to the VA. This is in addition to the 3% – 5% of the loan amount that you will pay in closing costs.
You May Pay a Higher Interest Rate
Lenders base your interest rate on the riskiness of your loan as well. Because increasing your loan amount is risky, you may automatically expect a higher interest rate. That’s not the only factor they consider, though. They also look at your credit score, debt ratio, and your ability to repay the loan.
The lower your credit score or the worse your credit history, the higher the rate a lender may charge. They have to make up for the risk you pose by making money when you do make your payments. If you have compensating factors to make up for the low credit score, such as a low debt ratio, it may help offset the increase the lender would require.
In general, though, interest rates are higher on cash-out refinances just because you borrow more than you originally owe, putting the lender at risk.
You Put Your Home at Risk
Anytime you take out a new mortgage, you put your home at risk. If you stop making your payments, the lender can take possession of your home. That’s likely the last thing they want, so they will do what they can to get you to make your payments. But if it comes down to it, the bank could take your loan.
Before you take out a cash-out loan, make sure you can comfortably afford the payments. Don’t focus on the present alone; look at the future too. Do you see your financial situation changing? Will the higher loan payment be something you can afford?
You May be Enabling Bad Habits
Stop and think why you need to take cash out of your home’s equity. Yes, the cash is there and it’s yours to use, but it’s an investment. Wouldn’t you rather save that equity for when you retire? If you downsize, you can sell your home, buy a smaller home in cash, and keep the remaining funds for you and your family to live on for your golden years.
If you tap into the cash in the home, you take away that investment. Are you taking it out to invest back into the home? Maybe you are adding a room or making renovations. That might make sense. But, if you are taking the cash out to consolidate debt or pay for another expense that you can’t afford, you may just be enabling bad habits, continually putting yourself in debt.
This doesn’t mean that using the VA cash out refinance option should never be used. You should proceed with caution, though. Make sure you can afford the higher payment and that taking the money out makes sense. If it’s for something other than your home, you may want to consider other ways to save your money. If it’s your only option, make sure you shop around and find the best deal that is available to you.