Florida retiree Leroy George had unpaid bills piling up and wanted to fatten his emergency savings account. Those financial goals spurred him to tap his home equity through a cash-out refinance.
But when George asked about a cash-out refinance using a conventional mortgage, he learned he could borrow no more than 80 percent of the value of his home near Jacksonville.
“I said, ‘That won’t be enough money,’” George recalls.
George spent more than 17 years in the U.S. Navy, and his military service qualifies him for a loan through the U.S. Department of Veterans Affairs. VA loans offer many generous benefits — not just the option to buy a home with no money down but also the ability to tap up to 100 percent of a home’s value through a cash-out refi.
George took out a VA loan through ClearPath Lending for about 92 percent of his home’s value. He pulled out about $60,000 in home equity.
How VA cash-out refis work
Soaring home values mean American homeowners are sitting atop a pile of equity. A traditional cash-out refinance allows you to extract some of the equity from your home. Say you owe $200,000 on a home that’s worth $400,000. With a conventional cash-out refi, you could borrow up to $320,000 — 80 percent of your home’s value — and use the proceeds to pay down your $200,000 mortgage and closing costs, then keep the rest of the cash for any purpose.
Conventional loans limit cash-out borrowers to loan-to-value (LTV) ratios of 80 percent. VA loans are much more generous, not only in terms of credit score requirements but also in the amount of cash a homeowner can tap.
“Veterans have the ability to go a full 100 percent loan-to-value,” says Adam Mercado, director of operations at ClearPath Lending.
There can be a cost, though: Borrowing more than 90 percent of the property’s value will require the borrower to pay an additional fee of 1.5 percent to 2 percent of the loan amount, Mercado says. So on a $400,000 loan, tapping all of your equity will cost $6,000 to $8,000.
However, VA borrowers can tap up to 90 percent of their equity with no price adjustment, Mercado says.
While this option should be used cautiously, a cash-out refi can be a good way to pay for home repairs or to pay down high-rate credit card debt.
Why you should tap equity — and why you shouldn’t
Just because you can tap your home equity doesn’t mean you should. Here’s a breakdown of reasons to pull cash out of your home, along with guidance about whether that rationale makes financial sense:
Home improvements and repairs: Green light
Home improvements are likely to last for years, a time frame that matches the horizon of mortgage debt. Kitchen renovations and bathroom updates are no-brainers, but non-essential projects, such as a swimming pool or a game room, won’t necessarily reward you with a corresponding increase in property value. If you need a new air conditioner or an updated electrical system, though, a mortgage is the cheapest money you’ll find.
Consolidating debt: Yellow light
If you’re carrying credit card debt and paying double-digit interest rates, it could make sense to swap out expensive revolving debt for historically cheap mortgage debt. This strategy comes with a big caveat, however: Pull cash out of your house to pay off the credit cards only if you’re not going to simply run up more credit card debt.
The VA loan program imposes no minimum credit score, but most VA lenders require a score of at least 600 to 620. That number indicates a borrower has experienced some hiccups in managing credit, so VA borrowers should be especially cautious about tapping all of their equity.
Homeowners who use home equity as a lifeline can dig themselves a deeper hole in the long run, financial experts warn. If you follow up your cash-out refi with more spending, you’ll face a cash squeeze but with less of a home equity cushion to pad the fall.
Investing: Yellow light
As with using home equity to pay down debt, the calculus around investing is nuanced. If you want to tap cheap mortgage money to shore up your retirement savings and put those proceeds in a well-diversified portfolio, financial pros give their blessing.
On the other hand, if you aim to tap equity to day-trade stocks or to play the cryptocurrency boom, the smart advice is to think again. Such a gambit might pay off, or you might lose big.
Paying down student loans: Yellow light
This one is also a bit of a gray area. If you owe student loan debt to private lenders, it can make sense to pay those down by tapping home equity because they tend to carry higher rates and have less flexibility around repayment.
If you have federal loans, however, you need not rush to pay them down. Their relatively reasonable interest rates and income-based repayment plans mean federal student loans might not be as crippling a form of debt.
Going on vacation or buying electronics: Red light
Think of it this way: Your home loan’s term is 15 or 30 years because real estate is a long-lived asset that will give you years of use and almost certainly gain value. A Caribbean cruise or a gaming console, in contrast, will be long forgotten despite having to pay it off for decades. If a cash-out refi is your only option for paying for a vacation or another big-ticket item, better to put the purchase on hold.