Can You Use a VA Loan to Refinance a House

By Ciaran John

The United States Department of Veterans Affairs insures mortgages, known as VA loans, for military veterans and service men. The VA insures both purchase loans and refinance mortgages. The VA, in partnership with lenders across the nation, offers two types of refinance loans: interest rate reduction refinancing loans and cash-out refinances.

Veterans with existing loans backed by the VA can lower their monthly interest rate by taking out an interest rate reduction refinancing loan, or IRRRL. The borrower can only pay off an existing loan and cannot extract cash to consolidate other debt. The IRRRL uses the same appraisal as the original loan to determine the property value. The new loan must have a lower interest rate than the existing loan with the exception of situations when borrowers pay off variable rate loans with fixed-rate loans.

The VA insures cash-out refinance loans equal to up to 90 percent of a property's value. The borrower must use some of the loan proceeds to payoff an existing first lien mortgage so a borrower with no existing mortgage cannot use the loan simply to extract equity. Aside from paying off the mortgage, borrower's can extract additional funds to consolidate second lien mortgages, payoff other debts or use funds for any other legal purpose.

Generally, lenders require borrowers to have at least 20 percent equity in a home in order to refinance an existing mortgage. Borrowers using IRRRLs can borrow up to 100 percent of a home's value because the VA insures the lender against some of the losses incurred by a borrower default. The VA makes up for the absence of a borrower down payment by insuring up to 25 percent of the loan amount, which means lenders are only at risk for the other 75 percent of the loan balance if the borrower defaults.

Borrowers who take out VA refinance mortgages do not have to pay for private mortgage insurance, even though lenders normally require PMI in instances where borrowers have less than 20 percent equity. However, the borrower must instead pay a VA funding fee, which effectively serves as PMI. The VA uses the funding fees to cover payouts to lenders when borrowers default on loans. Borrowers must pay for PMI premiums out of pocket, whereas on a VA refinance, borrowers can roll the VA funding fee into the loan amount.

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