Is doing a VA cash-out refinance a good idea? Here’s what to know

Florida retiree Leroy George was trying to tap his home equity: He had unpaid bills piling up and wanted to fatten his emergency savings account. But he could borrow just 80 percent of his home’s value via conventional routes, like a cash-out refinance or home equity loan, which wasn’t enough for his needs. To the rescue: the U.S. Department of Veterans Affairs (VA). George was eligible, thanks to his 17 year-plus stint in the U.S. Navy, to get a VA cash-out refi, and ended up with a payout close to 92 percent of his equity stake.

If you have served, or are still serving, in the U.S. military, you may qualify for a loan or cash-out refinance through the VA. VA mortgages and refis offer many generous benefits, including the ability to finance or tap 100 percent of a home’s value.

But does that mean a VA cash-out refinance is a good idea? Not always.  You have to consider what you want the funds for, and weigh other concerns to decide if a VA cash-out refi — or any cash-out refi, for that matter — is the best option for you.

Times when you should tap into your home equity with a VA cash-out refinance

Just because you can tap your home equity doesn’t mean you should. Cash-out refinances — which involve exchanging your current mortgage for a larger one, pocketing the difference in ready money — can be tricky products.

Homeowners who have built up sizable equity in their properties and are confident in their ability to cover increased mortgage payments are often good candidates for a VA cash-out refinance.

However, the reason you need the money can be a factor too. Here’s a breakdown of good rationales for pulling cash out of your home.

Home improvements and repairs

“Many people run into home improvements that they cannot afford to pay cash for,” says Jason Bower, vice president of lending for Epic Mortgage in Brookfield, Wisconsin. “A new roof, siding, windows and other remodels with a good return on investment can all be great reasons to utilize a cash-out VA refinance.”

Making major fixes, remodel and upgrades with cash-out refi money can be a shrewd move: You’re using your home equity to improve your home’s value, which in turn boosts the worth of your homeownership stake. But the key is the enhance-value/return-on-investment part. Be cautious with non-essential additions like swimming pools or lavish fire pits that may not necessarily up your property’s worth in a significant way. Avoid going overboard with projects like kitchen and bathroom upgrades: the more you spend on them, the less likely they are to recoup their cost.

On the other hand, if you need essential upgrades like a new central air or an improved electrical system, doing a cash-out refi can be a cost-effective way to finance these projects. By utilizing mortgage funds, you can take advantage of favorable interest rates and spread the cost over a longer period.

Consolidating debt

It may be beneficial to replace high-interest credit card debt with mortgage debt, which historically offers lower interest rates. However, there is an important condition to keep in mind: If you pay the bills with cash-out refi funds and then run up big credit card balances again, you may find yourself in a tighter financial situation with a diminished home equity cushion to soften the impact.

While the VA loan program does not enforce a minimum credit score for borrowers, most VA lenders typically require a score of at least 600 to 620. Categorized as a “fair” (as opposed to good or excellent), this sort of score indicates that the borrower has faced some challenges in managing credit, making it crucial for VA borrowers to exercise caution when utilizing their equity.

Only opt to withdraw funds from your home to pay off credit cards if the balances grew due to one-time expenditures. And/or if you are committed to avoiding accumulating more credit card debt in the future.

Investing

Taking on debt for investment purposes — borrowing money in the hopes of making money — can also be a good strategy, though it’s not without controversy.

Bower advises using the tapped equity to purchase an investment property, such as a duplex or small apartment building.

“Most VA loan borrowers do not know that they can actually utilize their VA loan benefit to purchase a two- to four-unit property,” he notes. Just be aware that you must live at that property (in at least one of the units) as your primary residence; if you do, you are allowed to rent out the other units.

Another good use: If you intend to apply the liquidated equity to bolster your retirement savings — investing in low-risk, low-cost ETFs or mutual funds — or diversify your portfolio.

However, if your goal is to start day-trading stocks or participating in the cryptocurrency craze — think twice. These moves carry significant risk, and while there is a possibility of significant gains, there is an equal chance of substantial losses.

Paying down student loans

This situation can be a bit tricky to navigate. If you have student loan debt from private lenders, it could be beneficial to use your home equity to pay it off. Private loans often come with higher interest rates and less flexible repayment options, so tackling them first makes sense.

However, if you have federal student loans, there’s no need to panic about paying them off quickly. These loans usually have reasonably low interest rates and offer income-based repayment plans. As a result, federal student loans may not burden you as much as other types of debt.

Times when you should not tap your home equity with a VA cash-out refinance

Not every scenario is worthy of pulling the trigger on a VA loan cash-out refi. Avoid the urge if any of the following situations apply.

Rising interest rate environments

Have a look at where prevailing interest rates are now, vis-à-vis when you got your first mortgage.

“It may not be a good idea to refinance using a cash-out VA loan if your new interest rate isn’t significantly lower than your current one, or if the closing costs and fees outweigh the benefits,” cautions Dennis Shirshikov, a strategist for Awning.com and a professor of economics and finance at City University of New York. “Moreover, if you don’t plan to stay in your home long enough to recoup these costs, or if you have insufficient equity, it is generally not advisable. And pulling too much equity out of your home can also be risky if the housing market drops.”

Going on holiday

Consider this perspective: Your home loan is structured to span 15 or 30 years because real estate is a durable asset that provides long-term benefits and is likely to appreciate in value. On the other hand, indulging in a Caribbean cruise or two-week sojourn in the South of France may seem enticing, but the enjoyment quickly fades away while you’re left with years of repayment. If resorting to cash-out refinancing is your only means of funding a getaway, it’s wiser to postpone the trip.

High-priced home items

Likewise, resist the temptation to liquidate your home’s precious equity for just keeping up with the Joneses. In other words, pass on a cash-out refi to pay for things like new furniture, cutting-edge home electronics or ultra-lavish landscaping that don’t substantially improve your home’s value.

Big-ticket purchases

Apply the same rule to purchasing a new vehicle (car, boat, plane) or major one-time event (wedding, anniversary party). If you must borrow to afford such expenses, chances are you can obtain alternative financing at a relatively favorable interest rate for these items  without messing with your primary mortgage loan.

Keeping up with household bills

Financial experts caution homeowners against relying too heavily on home equity as a means of ongoing support. Taking on a 30-year loan to cover monthly costs like childcare, groceries, utilities and regular home maintenance is not a sustainable lifestyle. If you find yourself with cash-flow problems due to a sudden problem, like a job loss, you could consider it; but set yourself a tight budget and timeline to pay the loan back as soon as possible.

Alternatives to a VA cash-out refinance

Tapping into your home equity through a VA loan is not the only option. If you are in need of some cash, consider these alternatives:

• Standard cash-out refinance: You may be able to get a standard cash-out refinance loan. The terms probably won’t be as generous, but the process may be quicker.
• Home equity loan/line of credit: HE loans and HELOCs also provide ways to tap your ownership stake, usually up to 80-85 percent of your home’s worth. These don’t affect your original mortgage; they’re additional debt. Their interest rate will likely be higher than a refi’s, though.
• Shared equity agreement: You sell a percentage of your home’s equity to an investment company in exchange for a lump sum. Since the money is an investment, not a loan, you have no repayments to make. When you sell your home or the agreement’s multi-year term ends, the investor gets their money back, and often an additional amount, based  on the current value of their ownership stake  in your home.
• Personal loan: You don’t have to touch your home equity at all: You may be able to take out a personal loan at a competitive rate, if you’ve a strong credit score. However, you may not be able to borrow as much and the repayment term will be shorter.

Bottom line: Is a VA cash-out refinance a good idea?

The experts agree: Pursuing a VA loan home equity cash-out refi can be worth it if you meet recommended criteria and your use for the cash is one that should ideally grow wealth over time and/or decrease your overall debt.

“I would recommend utilizing your VA cash-out refinance option if you have home improvements that you want to do, have excessive debt to pay off or are interested in purchasing investment properties,” Bower says.

Still, the right answer will depend on your situation. “If you have a substantial amount of high-interest debt, need significant cash for a valid reason and are likely to get a lower rate or better loan terms, it can be a good option,” explains Shirshikov. “But always consider the costs, the new loan terms and your long-term financial plans.”

Additionally, consult closely with an experienced mortgage expert who can examine your financial objectives, help you weigh the costs and benefits and offer tailored guidance depending on your specific circumstances.

Frequently asked questions on VA cash-out refinances

• What is a VA cash-out refinance and how does it work?

  A VA cash-out refinance is a type of mortgage guaranteed by the Dept. of Veterans Affairs (VA). It essentially swaps your current mortgage for a new VA loan that comes with improved terms — primarily, more principal. You can take out the extra amount — which is based on the value of your stake property —  in ready money. You can use this money for different purposes, like making upgrades to your home or paying off debts. Even if your current mortgage isn’t a VA loan, you can still do a VA cash-out refinance (assuming you qualify, of course).
  

• Can you pull out 100 percent of your home equity with a VA cash-out refinance?

  Yes, you are allowed to pull out 100 percent of your home’s appraised value using a VA cash-out refinance, assuming your lender permits it.
  

Additional reporting by Emma Woodward