How does a VA cash-out refinance work?

What is a VA cash-out refinance?

A VA cash-out refinance is a way for veterans to refinance a VA mortgage or non-VA mortgage for cash, using the equity in their home to help with home renovations, debt repayment or other financial situations. A VA cash-out refinance means you replace your current loan with a new one – ideally with better terms and interest rates. This refinancing option is not the same as a home equity loan or home equity line of credit, known as HELOC.

Steps of a VA cash-out refinance

Once you decide you want to apply for a VA cash-out refinance, there are several steps to take.

1. Find a lender offering this type of loan, such as a mortgage company, credit union or bank.
2. Obtain your Certificate of Eligibility (COE) to show your lender you qualify.
3. Provide copies of financial paperwork. This should include:
   1. Paycheck stubs for the last 30 days.
   2. W-2 forms for the last two years.
   3. A copy of your federal income tax returns for the last two years (not all lenders require it, but many do).
   4. Any other information a lender requests.
4. Prepare to pay closing costs as well as a possible VA funding fee.

Requirements for a VA cash-out refinance

You must be a veteran, an active-duty military member who has served a minimum of 90 consecutive days, a member of the National Guard or Reserves with at least six years of service or a surviving spouse to qualify.

Several other minimum requirements also be met:

• You must live in the home from which you're taking out equity.
• You must obtain your Certificate of Eligibility (COE).
• You must have a required credit score of 620 or higher. Each lender will vary on their minimum.
• Your debt-to-income (DTI) ratio requirement generally must be less than 41%.
• You must show proof of income.
• You will likely have to pay a VA cash-out refinance funding fee.

Pros and cons of a VA cash-out refinance

Considering a VA cash-out refinance requires reviewing interest rates, loan terms, monthly payments and any potential risks. And you must also meet all qualification requirements. If your current loan is an adjustable-rate mortgage, you may want to switch to a fixed rate to have the same monthly payments for the remainder of the loan.

A benefit of this type of loan is that it lets you take equity from your home to receive cash for use with home renovation, education, paying down debt or other financial situations. Potential downsides to this type of loan include the additional costs of VA funding fees and closing costs.

Factors to consider before refinancing

Whenever you choose to get a loan, knowing your financial circumstances is key. Not only do you need to qualify, but you also want to be sure it's the best option for your financial situation. Knowing how you'll use the money can help you decide if this is the most financially savvy choice.

For example, if you're using this loan to pay off debt, you want to make sure that your payments will be less after getting a VA cash-out refinance. "You can measure this with a simple debt consolidation calculator or have a loan officer run the numbers for you, " said John Aguirre, a mortgage loan originator at the brokerage Loantown in Del Mar, California. "This is an important measure, because if someone has only 20 years remaining on the mortgage, then they pursue a refinance, it might reduce the monthly cash flow while making the aggregate total of debt payments higher."

Even if this is an ideal option, you need to have a good credit score as well as a debt-to-income (DTI) ratio less than 41%. Some people may need to work on increasing their credit score and reducing their debt before applying for a VA cash-out refinance.

Bottom line

Applying for a VA cash-out refinance can be a beneficial option for any active military or veterans who want to use the equity in their home to get cash for other uses. This is also an opportunity to lower your interest rates and get better loan terms. Homeowners should consider their financial situation and goals to determine if it makes sense to take equity out of their home for cash while also paying closing costs and a funding fee and agreeing to new loan terms.