Chapter 24: Easily Exchangeable Loans - The VA Streamline Refinance
When Should You Refinance Your VA Home Loan? The Tremendous Advantages of a VA “IRRRL”
Advertisements for VA loans are everywhere. You hear radio ads, TV commercials, and if you have a VA loan already, your mailbox gets filled every week with solicitations. If rates click down just a notch, there’s a massive pile of mail screaming for your attention! Is this stuff for real? There’s just an avalanche of it with bold claims of “lower rates.” Why does it seem as if having a VA loan makes you a target for solicitors? Where do these people who call you get your number from? Should you respond to any of these offers?
Refinancing, by definition, is simply replacing old financing with new financing (a new mortgage) because the new terms are more favorable to you. In the money game, it’s the ultimate do-over, a second (or third or fourth…) chance to take advantage of a new opportunity. Homeowners with VA home loans consider refinancing for a variety of reasons, including to obtain a better interest rate, to reduce monthly payments, to consolidate debts by paying off credit cards, or to free-up cash, often for home improvements. There are four reasons to refinance:
- You have a fixed rate and lower rates are now available (e.g., if you have a 5% loan and 4% is now available). Such a “refi” is considered a fixed rate to fixed rate.
- If you have an adjustable loan and want the security of a fixed rate loan. Often in this case, people were enticed by the really low start rate that was offered, and now they want to go back to a fixed rate.
- Some people have a fixed rate but want the lower payments that are available on an adjustable loan. Such a refi is called a fixed to adjustable.
- If someone wants a cash-out refinance, typically where the homeowner’s property has appreciated (e.g., the property was purchased for 400K three years ago and the property values went up 25% so now it is worth 500K), and you want to take out funds for home improvements, debt consolidation or other reasons. (See Chapter 22: The Cash-Out VA Refinance vs. An Equity Line for in-depth detail on financing options.)
Homeowners who purchase a home using their VA Home Loan Benefit often don’t understand the compelling reasons to refinance. They may be skeptical of all the solicitations. Or they may have had a bad experience getting their purchase loan. Or they maintain a stubborn stance because they simply don’t want to “start all over again” with a new loan because their goal is to pay off the debt, pure and simple. This is the biggest mistake. There are a host of reasons creating resistance when it comes to refinancing and preventing our men and women who serve from taking advantage of a bona fide, legitimate opportunity to achieve better terms on a new loan. This is especially true as it pertains to a “fixed rate to fixed rate” refinance.
It’s very common for a buyer to purchase a property with a fixed rate and then come up with a list of objections as to why they will not refinance to a lower rate. Unfortunately, many of these objections are “self-invented myths” that prevent our VA borrowers from improving their financial situation. Often the improvements can be life changing with respect to properly managing their finances.
- “It’s too much of a hassle.”
- “I’ll have to write a check up front or at closing.”
- “I disliked my previous loan office/mortgage company.”
- “My grandfather told me the rate needs to be at least 2% lower.”
- “I don’t understand or trust the process, and I’m skeptical of all the solicitors.”
- “I find the whole thing intimidating.”
- “It’s too much paperwork.”
- “It costs too much.”
- “My transaction costs were $10,000 – there’s no way I’m paying that again.”
- “My loan balance goes up.”
- “I need equity, or my house is ‘upside down.’ I owe more than it’s worth.”
- “I’m retired and won’t qualify.” “I changed jobs.” “I’m self-employed.”
- “I don’t want my property taxes to go up.”
- “I need an attorney to review all the papers, and I can’t afford one.”
- “My credit’s not good enough.”
This list of roadblocks goes on and on. But the most financially debilitating or damaging “opinion” or feeling from many homeowners is this:
“It was so much effort and cost to get that loan! And it seems that I just did it….. I feel like I’m losing out and not taking full advantage of the loan I got if I replace it with a new loan.”
There is a strong emotional attachment to the effort and/or expense which produced a loan that is NOW OBSOLETE. I totally understand this feeling. However, the inability to release yourself from that gripping emotional attachment and the resulting paralysis and lack of action can have serious financial consequences. Not refinancing when the opportunity presents itself is simply financially foolish. This INACTION is perhaps the most financially damaging and irresponsible choice that a Veteran can make. Unfortunately, it is too common.
A NO POINTS, NO FEES, NO COST VA LOAN REFINANCE IS A “FREE” LOAN.
If you’re not taking any cash out (you are only reducing your fixed rate or replacing an adjustable VA loan with a fixed rate), your transaction is called a VA streamline refinance. In lender’s terms, it is called an Interest Rate Reduction Refinance Loan or IRRRL. It is typically the easiest loan to qualify for among all loan applications. Very little is required from a client to produce the result.
Lenders can literally construct a no-points, no-fees 30 year fixed rate loan program, without your loan balance going up above your current principal balance. When funded, your new loan balance will be the same as your old loan balance. As an example, imagine you’ve got a $300,000 loan at 5.00%, and rates have dropped allowing new choices of rates between 3.75% - 4.50%. When you choose the rate of 4.50% (obviously the rate at high end of the range), special things can happen for you. Here’s how the math makes a “free” loan work for all parties. First, you’ll pay 0.50% less in interest for the life of the loan, and it didn’t cost you anything. Your initial reaction may be skeptical because you ask, “What’s in it for the new lender? How do they get paid?” Good question. Here’s how.
At the highest end of the available interest rate range (4.50% vs. 3.75% in this example), a large sum of money is available to pay for closing costs and provide enough for the lender to earn a reasonable profit. These funds are universally available to distribute to all parties in the transaction, including the lender and the lender’s loan officer.
More importantly, funds are available to the borrower to pay for all the typical closing costs, including funding the new impound account for taxes and insurance as well as interest to bridge the gap between the old loan and the new loan. These funds are not available when choosing the lowest rate options. Here’s WHERE the funds come from.
If you’re an investor, you’ll be happy to advance a measured sum of money, literally pay some money UP FRONT, for the opportunity to receive a higher yield / higher rate of return on your investment and larger distributions or larger regular payments to you for the life of the investment. As an investor, you PAY a little up front and get a bigger return in the long run. This investor is known as GNMA – the Government National Mortgage Association. The loan is sold by the lender and purchased by GNMA. GNMA facilitates the “secondary loan market” by placing your loan into a GNMA investment security with thousands of other loans. GNMA then sells these securities or investments to “institutional investors” such as large insurance companies. Through this process, there’s plenty of money that is “advanced” through the “loan food chain,” into your loan closing to pay for closing costs, when you choose the higher rate!
If you select a lower rate, the yield or rate of return to the investor drops. These funds available for your closing costs disappear as you slide down the scale of rate choices for your new loan. In the “lower rate” scenario, the lack of these available funds translate into an increased loan balance as closing costs are financed, or simply added to the new loan balance.
Again, when you’ve selected the higher rate, and as the transaction funds, money flows forward from the lender into your escrow account (at the title company). Because these funds pay for your closing costs, the loan balance does not need to be increased as it would with a “higher-rate” choice where these funds are not available.
The Highlights and Benefits of the “Free” VA Loan
- No added loan balance: Because you have chosen the higher rate option, your loan balance has not increased, and your new loan is properly budgeted to pay your property tax liabilities, your insurance premiums and the interest due to both the old lender and new.
- Skipping two payments: When two months of interest is included in the transaction, you will bypass two mortgage payments. Those funds stay in your checking account. There is no effect on your good credit as long as your old loan is paid off and credited to the old lender on or before the last day of the month in which you held back your final payment. Interest then accrues in the following month after funding your new loan. This results in your first payment due on the new loan on the 1st of the following month after funding. Again, you bypass two payments. That is the “cherry on top” of this refinance!
- Escrow impound account refund: Because you have chosen the higher rate option, your new impound account has been funded with the lender’s money, not yours. What has become of your previous escrow impound account with your previous loan servicer? Those funds were always yours and were set aside to pay for your taxes and insurance.
- When the previous loan was paid off, it triggered and audit by the previous loan servicer. If your old escrow impound account was running a deficit at payoff, no refund is due. This is a rarity. If that was the case, your old payment was about to be raised to cover the deficit. If there existed a “surplus” in your escrow impound account, then these surplus funds must be returned to you promptly, usually within 30 days of pay off. Escrow impound accounts are typically budgeted to operate at a surplus, so a refund to you is common on a VA refinance.
- No money out of pocket.
- A new loan balance equal to your current loan balance.
- A lower 30 Year Fixed Rate mortgage payment.
- Bypass two months of payments (with no affect to your good credit).
- A substantial impound account refund from your current lender.
