VA Cash-Out Refinance: Type I and Type II

What a VA cash-out refinance is

A VA cash-out refinance replaces your current mortgage with a new VA-guaranteed loan. Despite the name, you do not have to take cash out. It is the VA's all-purpose refinance. You can use it to:

• Take cash from your home's equity for debts, school or repairs
• Refinance a conventional, FHA or USDA loan into a VA loan, often to drop mortgage insurance
• Refinance an existing VA loan when you want cash out or need to change more than an IRRRL allows

One key limit: a cash-out refinance requires you to live in the home now. If you have moved out and rent the home, an IRRRL is usually your only VA refinance option.

Type I vs. Type II

VA splits cash-out refinances into two types:

• Type I: The new loan amount, including the funding fee, is not more than the payoff of the loan you are refinancing. You are mostly changing loan types or terms, such as moving from FHA to VA.
• Type II: The new loan amount is more than the payoff. This is the classic cash-out loan.

Both types need a new VA appraisal, a full credit and income review, and a COE.

Protections built in

Because cash-out loans can be risky, VA added rules to make sure they help you:

• Net tangible benefit: The lender must show the loan helps you. Examples include a lower rate, a lower payment, removing mortgage insurance, switching an ARM to fixed, or taking needed equity.
• Seasoning: If you are refinancing a VA loan, the same six-payment and 210-day rule as an IRRRL applies.
• Recoupment: For Type I loans, costs generally must be earned back through savings within 36 months.
• Home equity disclosure: For Type II loans, the lender must show how much equity you will have left after the refinance compared to before.
• Loan-to-value: The new loan is capped based on the appraised value. VA generally allows up to 100% of value including the funding fee, but many lenders set a lower limit, such as 90%.

Costs

• Funding fee: 2.15% for first use, 3.3% after, unless you are exempt.
• Closing costs: appraisal, title, recording and the lender's flat charge. These can usually be included in the loan, up to the allowed limit.
• Interest: You may end up with a higher rate than your current loan if rates have gone up.

Step by step: VA cash-out refinance

1. Decide your goal. Cash for debts? Dropping FHA insurance? A better rate?
2. Estimate your equity. Look at recent sales nearby and your payoff balance.
3. Get your COE and gather pay stubs, W-2s and, if needed, tax returns.
4. Compare at least three lenders. Look at rate, fees, and their max loan-to-value.
5. Order the VA appraisal through your lender.
6. Review the disclosures, including the net tangible benefit and equity comparison.
7. Close. There is a three-day waiting period on most refinances of a primary home before funds go out.

Is it worth it?

Cash-out can make sense to pay off high-interest debt or fund a major repair. But you are turning short-term debt into a 30-year mortgage on your home. If you fall behind, your home is at risk. Ask yourself:

• Will the new payment fit easily in your budget?
• Are you trading a low rate for a higher one on your whole balance?
• Could a home equity loan or line keep your low first mortgage in place?

Bottom line

The VA cash-out refinance is flexible and can help you leave FHA or conventional loans behind. Just make sure the numbers truly work for you, and be careful about borrowing against your home for spending.