When refinancing an existing VA home loan, typically the primary reason is to lower the interest rate and lowering the monthly payment. It can also make sense to refinance out of an adjustable rate loan into a fixed rate. Yet during that process, borrowers may also have the option of pulling a little bit of cash out to be used for anything the borrowers care to pay for. College tuition, paying off credit cards or even taking a well-deserved vacation. Lately there have been advertisements on television from lenders that let veterans know they can pull cash out of their homes up to 100 percent of the value of their home. Is that a good thing?
Maybe, maybe not but if you do some of the math it might be better to hold off pulling every bit of equity out of your home to spend on other things. Why? First, the funding fee for a cash out refinance can be as high as 3.30 percent of the loan amount. No, but you don’t have to pay the funding fee and you can roll this amount into your loan just as you did when you purchased the home with a VA loan. On a $200,000 mortgage, the funding fee is $6,600.
Over the term of a 30 year loan, the amount of interest paid is more than $5,000. Even if you didn’t keep the loan for 30 years, as most never do, the interest charged over the next seven years is more than $3,000 using a 4.00 percent rate and the original $6,600 is only paid down to about $5,600.
Next, should you in fact refinance 100 percent of your value, what happens if you suddenly need to sell? If your loan is at or near 100 percent of the sales price of the home, you’ll have to come to the closing table with several thousand dollars just to pay closing costs associated with selling a home. You have no equity.
Finally, just because the VA says you can do a cash out loan doesn’t mean a VA lender will approve such a request. Most lenders limit cash out refinances to 90 percent of the value of the property and even as low as 80 percent for the very reasons listed above.
Sometimes what you can do and should do are two entirely different things. And eliminating your equity with a cash out refinance just might be one of those times.