Should you refinance your VA loan?

This is the first thing to get straight, because every other programme has one. Under 38 U.S.C. 3709 and 38 CFR 36.4306, VA recognises exactly two refinances: the Interest Rate Reduction Refinance Loan, and the cash-out refinance. Anything that is not an IRRRL is a cash-out, even when the borrower takes no cash at all.

The cash-out category is then split in two:

The funding fee counts in that test, which catches people out. There is no allowance that lets a Type I loan exceed the payoff by the amount of the fee, if the fee pushes it over, the loan is a Type II. That reclassification matters, because Type II is exempt from the recoupment rule and Type I is not.

Sources: 38 U.S.C. 3709(d); 38 CFR 36.4306; VA Circular 26-19-5.

The single rule most likely to stop a VA refinance. 38 U.S.C. 3709(a) requires that all fees, closing costs and expenses be recouped through lower monthly payments within 36 months of the note date.

Two consequences worth knowing. First, because the funding fee is excluded from the numerator, a large fee does not hurt the test, which is why an exempt borrower and a non-exempt one usually get the same answer. Second, because the denominator is principal and interest only, a refinance that lowers your payment mainly by re-escrowing does not recoup anything.

When a loan is close to the line, the fix is a lender credit rather than a lower rate: credits reduce the numerator directly, while a lower rate only widens the denominator slowly.

Type II is exempt by statute, and VA said why when it wrote the rule. The cash a veteran takes out may go to tuition, medical care or paying off debt, and requiring those costs to be recouped through a lower payment “would put a veteran in a worse financial position than a non-veteran.”

Sources: 38 U.S.C. 3709(a) and (d); VA Circular 26-19-22; the 2018 cash-out final rule at 83 FR 64459; now codified at 38 CFR 36.4307 and 36.4306(b)(1).

The VA streamline. Generally no appraisal, no credit report and no income documentation, VA's Lenders Handbook says so in as many words. A credit review comes back only if the loan being refinanced is 30 or more days past due, or if the new payment rises by 20% or more.

Seasoning. The note date must be on or after the later of two dates: 210 days after the first payment due date on the loan being refinanced, and the date the sixth consecutive monthly payment is made. In practice that is about seven months from the first payment.

Rate reduction. 38 U.S.C. 3709(b) requires the new rate to be at least 50 basis points below the old one when refinancing a fixed rate into a fixed rate, and at least 200 basis points below when going from fixed into an adjustable rate. Unlike FHA, this is measured on the interest rate alone, there is no mortgage insurance to fold in, so no "combined rate" exists. The statute also bars a rate reduction produced solely by discount points unless those points are paid at closing rather than added to the principal.

Maximum loan. The balance being refinanced, plus authorised closing costs and a discount of up to two points, plus the funding fee. There is no loan-to-value test, because there is no appraisal.

No cash out. An IRRRL cannot return money to you or pay off other debts, with one exception: reimbursement of up to $6,000 of energy-efficiency improvements completed in the 90 days before closing.

Occupancy is looser. A purchase or cash-out requires you to occupy the property as a principal residence. An IRRRL only requires you to certify that you previously occupied it, which is how a veteran who moved and rented the house out can still streamline the loan.

Sources: 38 U.S.C. 3709(b) and (c); 38 CFR 36.4307; VA Pamphlet 26-7 Chapter 6.

A VA cash-out may not exceed 100% of the reasonable value established by the appraisal. That is generous, no other programme lets you take a loan to the full value of the home, but there is a catch that runs the opposite way to a purchase.

The funding fee must fit inside the 100%. 38 CFR 36.4306 requires that any portion of the fee which would push the loan above 100% of reasonable value be paid in cash at closing. On a purchase the rule is the reverse: 38 CFR 36.4313(e) lets the fee be financed “without regard to the reasonable value of the property.” Same fee, same programme, opposite treatment, and the reason a veteran who financed the fee on the way in sometimes has to write a cheque for it on the way out.

Seasoning, the 210-day and six-payment rule, applies to both Types when the loan being refinanced is itself VA-guaranteed. It does not apply when you are refinancing a conventional, FHA or USDA loan into VA, because there is no prior VA loan to season.

Occupancy as a principal residence is required, the same standard as a purchase.

A cash-out refinance, Type I or Type II, must satisfy at least one of the conditions at 38 CFR 36.4306(a)(3)(i). Not all of them; one.

Condition 1 is why refinancing an FHA loan with a life-of-loan premium into a VA loan is so often the right answer for an eligible veteran: it satisfies the benefit test on its own, and it removes a premium that would otherwise never have ended.

Note that the IRRRL has its own, shorter benefit test, lower principal and interest, a shorter term, ARM to fixed, energy improvements, or foreclosure prevention. The two lists get conflated constantly. They are not the same.

VA requires a side-by-side comparison of the existing and new loans, given to the borrower within three business days of application and again at closing. On a cash-out it shows the payoff and new loan amounts, loan types, rates, terms, the total of payments, the loan-to-value ratios, and, unusually, the dollar amount of home equity being removed and what that means on a future sale.

The IRRRL version discloses all fees and costs, whether financed or paid at closing, and the recoupment period. It is a genuinely useful document, and it is worth reading rather than signing.

Source: VA.gov, effective 7 April 2023. There is no down-payment reduction on a refinance, that schedule applies to purchases only. The fee is waived for a veteran receiving VA compensation for a service-connected disability, one entitled to it who takes retirement or active-duty pay instead, a surviving spouse receiving Dependency and Indemnity Compensation, a service member with a proposed or memorandum rating before closing, and an active-duty Purple Heart recipient.

The entitlement arithmetic works the same way it does on a purchase: with full entitlement there is no cap, and with partial entitlement the maximum guaranty is 25% of the county one-unit conforming limit less what has been charged. An IRRRL reuses the entitlement already committed to the loan, so it does not raise the question at all.

On a cash-out with partial entitlement, the effect is a ceiling on what a lender will write rather than a VA-mandated cash requirement, the statute and regulation do not name a dollar figure the veteran must bring. The practical constraint comes from the secondary market's expectation of 25% coverage. If your entitlement is partial and you are considering a cash-out, that is a conversation to have with the figures from your Certificate of Eligibility in front of you rather than an estimate.

The annual percentage rate is the rate that discounts every payment back to the amount financed. Counted as prepaid finance charges: origination and discount points, lender fees, prepaid per-diem interest, and the VA funding fee. Excluded, as 12 CFR 1026.4(c)(7) permits when bona fide and reasonable: title examination and insurance, escrow and settlement fees, document preparation, notary, appraisal, credit report, survey, and recording fees and transfer taxes.

Note that the APR's list and the recoupment statute's list are not the same. Recoupment excludes the funding fee and prepaid items; the APR includes them. A loan can recoup comfortably and still show an APR well above its note rate.

Closing costs divided by the monthly saving gives a break-even, and on a VA refinance it usually looks similar to the recoupment figure, but they are different tests with different inputs. Recoupment is a statutory gate measured on principal and interest with the fee excluded; break-even is a consumer question measured on the whole payment with everything included.

Neither says anything about the term. Refinancing a loan with 26 years left into a new 30-year loan lowers the payment partly because the rate fell and partly because the debt was stretched. This calculator shows the interest still to be paid under each loan alongside both figures, which is the comparison that actually answers the question.