There’s only one loan program that allows you to refinance even if you don’t have equity – the VA IRRRL program. It stands for the Interest Rate Reduction Refinance Loan and it helps veterans refinance their VA loan even if they are upside down on their mortgage.
The VA IRRRL program has many benefits including the fact that you don’t need any equity in the home.
You Don’t Need an Appraisal
The most notable benefit of the VA IRRRL program is the lack of appraisal needed. The VA allows lenders to use the original purchase price of the home for the value. This could mean a few things:
- You may have more equity in the home than the lender realizes if the home appreciated
- You may have less equity in the home than the lender realizes if the home lost value
Lenders do have a way of knowing what homes in the area did as far as value, though. They oftentimes run an automatic valuation (a computer-based program) just to see where home values are in the area. If home values fell too much, they may hesitate to refinance your loan, but that’s typically not the case.
The VA doesn’t require you to have an appraisal, or equity for that matter, because they rely on the fact that you have to benefit from the refinance. We discuss this in further detail below.
The Net Tangible Benefit Requirement
One of the main qualifying requirements of the VA IRRRL is that you benefit from the refinance. They call this the net tangible benefit. The VA wants to make sure that it makes sense for you to refinance. That’s because it costs money to refinance.
Let’s say it cost you $4,000 in closing costs to refinance. If you aren’t saving money, lowering your interest rate, or improving the term of your loan, it just doesn’t make sense to do so. That’s where the net tangible benefit comes into play.
The VA IRRRL program doesn’t allow you to take cash out of your home’s equity. If you don’t have any equity, it doesn’t make a difference, but it’s worth mentioning. It’s strictly a program to make your loan better or more affordable.
A Timely Mortgage Payment History
The other requirement is a timely mortgage payment history. Technically, your last 12 payments must be on time. In other words, you can’t have any late payments within the last year. The VA does allow one exception to that rule – they may allow one 30-day late payment, but it’s up to lender discretion. If they do allow it, you must be current on your mortgage at the time of application for the VA IRRRL.
You may wonder why they care about your mortgage payment history so much, but this is the main determining factor for the loan. Lenders don’t have to pull your credit, verify your employment, or even your income. They can use the fact that you made your last 12 months of payments on time as evidence that you shouldn’t have a problem affording a lower monthly payment or a payment on a more favorable loan.
The Downside of Refinancing With No Equity
Now it does seem amazing that you can refinance without any equity in the home, but you should know the downsides.
If you don’t have equity in the home and you refinance, you end up ‘deeper in the hole.’ You may even owe more than the home is worth. If you were to sell your home in the near future, there’s a chance you’d have to pay money at the closing rather than receive it, as the seller. That’s not an ideal situation.
If you aren’t moving soon, though, and you have a plan to get ahead on your mortgage, refinancing even if you are underwater can be beneficial. There aren’t any other loan programs out there that allow borrowers to refinance without any equity in the home.
Don’t forget, refinancing costs money, as we talked about above. This adds to the downside of the VA IRRRL. Whether you pay the closing costs out of pocket or you add them to your loan amount (you can add some costs), you deplete the benefit of saving money on the mortgage. In this case, you should figure out your break-even point. This is when you pay off the closing costs and start realizing the savings. You can do this with the following equation:
Closing Costs/Monthly Savings = Months to Break-even
A maximum 36-month break-even point is typically ideal unless of course you will move in less than 3 years, then a 36-month break-even point wouldn’t make sense.
The VA IRRRL program does make it possible to refinance without any equity in the home. That’s a definite plus. Make sure you look at the big picture though to make sure you are choosing the loan that will benefit you not only now, but in the future too.