How To Refinance From A Conventional Loan To A VA Loan

If you currently have a conventional mortgage but qualify for a VA home loan, it’s in your best interest to explore a refinance to the latter. You could lower your interest rate, say goodbye to private mortgage insurance, and, if you choose, liquidate home equity.

Find out if a refinance from a conventional mortgage to a VA home loan is right for you by reading this helpful guide, which covers the pros and cons of this move, what you’ll need to qualify, and what’s involved with the process.

A VA cash-out refi: Your ticket to refinance that conventional loan

Own a home that you financed using a conventional loan? If you made less than a 20% down payment, you’re likely paying private mortgage insurance premiums that can be costly.

And if you closed on that purchase loan in the last couple of years, chances are your interest rate is pretty high. 

But if you are an active duty military member, veteran, or surviving spouse, you should qualify for a VA home loan. These generous loans often charge among the lowest interest rates and do not require mortgage insurance or a down payment.

If you are eligible, you can refinance your conventional mortgage loan and replace it with a new VA cash-out refinance loan, even if you don’t plan to tap into your equity and take any cash out a closing. 

Quick note: If you already had a VA loan, you could fast-track the refi process by opting for what’s called a VA streamline refinance, also referred to as an Interest Rate Reduction Refinance Loan (IRRRL). Currently, however, the only way to refinance a non-VA loan into a VA-backed loan is by choosing a VA cash-out refinance loan.

Pros and cons of this strategy

Consider the benefits of refinancing from a conventional loan to a VA cash-out refi loan. Doing so can: 

• Lower your interest rate if rates have decreased, leading to substantial savings over the life of your loan. “VA loans often offer lower interest rates compared to conventional loans, which can save you big money over the life of the loan,” says personal finance expert Itay Simchi, founder of Proven House Buyers.
• Eliminate monthly PMI payments. “VA loans, unlike conventional loans for which you put down less than 20%, do not require PMI, which can result in substantial savings,” says Steven Parangi, owner of Alpine Mortgage.
• Refinance to a shorter loan term, such as moving from a 30-year to a 15-year mortgage, to build home equity faster and save significantly on overall interest.
• Switch from an adjustable-rate mortgage to a fixed-rate mortgage for greater stability and predictability in your payments.
• Lock in a lower rate and/or extend your loan term to decrease your monthly payments, freeing up cash for other expenses or investments.
• Liquidate home equity, if you choose, for major expenses like home improvements, education, or debt consolidation.

However, there are a few drawbacks to this strategy.

“Refinancing to a new VA loan will use up part or all of your VA loan entitlement, potentially limiting future VA loan eligibility if you, for example, want to purchase another home in the future,” says Kelly Miskunas, senior director of capital markets at Better.com. 

Also, just because VA loans tend to charge lower interest rates than other home loans doesn’t mean you are guaranteed to lock in at a lower rate than you are paying today. Additionally, borrowing cash can increase your total debt over time.

“In addition, refinancing will require paying a VA funding fee, which is currently 2.15% to 3.3%,” cautions Misukas. “The good news is that the VA funding fee can be rolled into the mortgage rather than paid in cash at closing.”

Lastly, as with any refinance loan, you’ll have to pay closing costs. These can average 2% to 5% of your loan amount.

Refinance Requirements 

To better determine if you are a good candidate for a VA cash-out refi, carefully consider the typical lender requirements, outlined below.

Credit Score

Your lender will scrutinize your three-digit FICO credit score, which is a reflection of your creditworthiness. The VA technically doesn’t set a minimum credit score for a VA loan, but many lenders require a score of 620 or higher. 

Income/assets

There is no minimum income requirement to refinance from a conventional mortgage to a VA cash-out refinance mortgage, but the lender will scrutinize your earnings and job stability nonetheless to assess your ability to repay.

“Borrowers must demonstrate stable and sufficient income to cover the loan payments. The lender will review income documentation, such as pay stubs, W-2s, and bank or tax statements,” Parangi notes.

DTI Ratio

Your debt-to-income (DTI) ratio helps lenders assess your ability to handle monthly payments and repay debts. It compares your total monthly debt payments to your gross monthly income.

To calculate your DTI, first sum up all your monthly debt obligations, including mortgage payments, car loans, credit card payments, student loans, and other recurring debts. Next, determine your gross monthly income, which includes your salary, wages, bonuses, and any other consistent earnings before taxes and deductions.

Divide your total monthly debt payments by your gross monthly income, then multiply the result by 100 to get your DTI percentage. 

The VA does not stipulate a maximum DTI ratio, but it advises lenders to apply extra financial scrutiny to borrowers whose DTI ratio exceeds 41%, “although higher ratios may be accepted with compensating factors,” adds Misukas.

LTV Ratio

Your loan-to-value (LTV) ratio helps evaluate the risk of lending by comparing the loan amount to the appraised value of your property. A higher LTV ratio signifies greater risk for the lender.

To calculate your LTV, first determine the total loan amount and the property’s appraised value, which typically requires a professional appraisal. Next, divide the loan amount by the appraised value and multiply the result by 100 to obtain the percentage.

Some lenders will permit up to 100% LTV for a VA cash-out refinance loan, but many lenders will cap the maximum LTV at 90%, per Misukas.

Property Details

Your home must be your primary residence and can be a single-family residence, duplex, triplex, or fourplex property. Your home cannot be used solely for investment or rental purposes; that means if you own a multi-unit property, one unit must be your primary residence.

“Also, your property must meet VA minimum property requirements, ensuring that it is safe, sanitary, and structurally sound,” Misukas continues.

Other Requirements

Because this is a VA loan, you must obtain a Certificate of Eligibility (COE) from the VA. This is a document issued by the U.S. Department of Veterans Affairs that verifies you qualify for a VA-backed home loan.

Additionally, the new loan must meet the VA’s net tangible benefit rules. These ensure that you will achieve a significant financial advantage from VA loan refinancing, such as a lower monthly payment, a shorter loan term, or increased payment stability.

If taking cash out, the funds must be used for beneficial purposes like home improvements or paying off high-interest debt.

Steps involved with refinancing

The process of refinancing a conventional mortgage loan into a new VA cash-out refinance loan will be similar to what you experienced when you obtained your original purchase loan. Expect to complete the following steps:

1. Check your credit and financials. “Ensure your credit score is in good shape, and gather necessary financial documentation, including recent pay stubs, bank statements, tax returns, and W-2 forms,” recommends Misukas. 
2. Research and select a refinancing lender by obtaining and comparing multiple rate quotes and loan offers from VA loan-participating lenders.
3. Complete and submit your loan application along with the required documentation.
4. Arrange for a professional appraisal of your home, which the lender will likely require and charge you for.
5. Wait for the underwriting decision as the lender reviews your application, documents, and appraisal report. “If you are approved, you will receive a commitment letter outlining the terms of the new loan,” Simchi says.
6. Close on the refinance loan by reviewing and signing all necessary documents and paying any associated closing costs. If you are opting to tap equity, prepare to receive cash out at closing.
7. Start making payments on your new loan, typically beginning one month after closing.

The Bottom Line

Shifting from a conventional loan to a new VA cash-out refinance loan can pay off, especially if you can lower your rate and do away with PMI. However, before committing, review your credit rating and financial status carefully, tally up the associated costs involved, including the funding fee and closing expenses, be sure you understand the terms of the new loan, and think about your long-term plans for the property.