Refinancing can seem like a good idea. Who wouldn’t want a lower payment, right? But there are certain risks you take when refinancing your VA home loan. Knowing the risks can help you decide if it’s right for you.
Lengthen the Term
If you are like most borrowers, you’ll automatically flock to the 30-year term. It’s the most common term and it has the lowest payment. It makes sense that you would want to take it. But you have to take into consideration the time left on your current loan. What if you already paid 10 years into that loan? If you refinance into a 30-year term, you just lengthened your loan’s term by 10 years. This will cost you a significant amount of money in interest, making the refinance risky.
You can sidestep this risk by calculating how much time you have left on your current mortgage and taking out a similar term with your VA refinance. For example, if you have 20 years left on your current loan, consider asking your lender for a quote on a 20-year loan. You may even want to consider the 15-year term to see if it’s a payment you can handle.
Pay Closing Costs
You can’t refinance free of charge. If you do, you’ll pay it in the interest rate (lenders charge a higher rate to eat the closing costs). Either way, the refinance will cost you something. Closing costs can add up to several thousand dollars depending on the chosen lender. You need to consider this when you figure out if refinancing makes sense.
The easiest way is to figure out your break-even point. All you need for this is the total of the closing costs and the monthly savings you’ll reap by refinancing. You can then use the following equation:
Total closing costs/Monthly savings = Break-even Point
Let’s say your closing costs will be $4,000 and you’ll save $100 per month by refinancing. Your break-even point would be:
$4,000/$100 = 40 months
If you will be in the home much longer than 40 months, refinancing could make sense. If you know you’ll move in the next 2 years, though, it doesn’t make sense to pay $4,000 to save $2,400.
Using Your Equity
It sounds so tempting when a lender tells you that you can tap into your home’s equity and have cash in hand. But does it make sense? What was your goal when buying the home? Are you relying on its return to help you during retirement? Will you sell the home and downsize, hoping to pay cash for the smaller home? How are you going to use the cash that you take out of the home?
The best practice is to leave your home equity alone. Unless you are going to make changes to the home, investing the money right back into it, leaving it alone makes more sense. Even if you want to use the funds to consolidate consumer debt, you are putting your home at risk for unsecured debts. Think long and hard before you make a decision like that. There may be other ways to consolidate your debt while leaving the investment you have in your home alone.
The Upside of Refinancing
Of course, there are benefits to refinancing your VA loan, especially if you are eligible for the IRRRL program. The benefits include:
- You may get a lower interest rate, which means the loan may cost you less in the end
- You may be able to lower your monthly payment without extending your loan’s term
- You can negotiate closing costs to keep them as low as possible
- You can tap into your home’s equity to make changes to your home that help your home appreciate
- You can have a safety net if you find yourself in financial trouble and need cash to bail you out
Before you refinance your VA loan, consider both sides of the equation. Make sure you will benefit from the break-even point and that you don’t extend your term. As long as you don’t let the lure of a lower interest rate or monthly payment make you refinance, you should be in good hands. Check with several lenders to make sure you are getting the best deal and make sure you really need the money you take out of the home’s equity, if any.