Home Equity Loan Options for a VA Mortgage

Life brings opportunities and challenges with financial consequences, and sometimes budgets get squeezed. If you’re a VA mortgage-holder, perhaps you’re pondering how to pay for some big-ticket item: a home improvement project, youngsters’ college expenses, emergency expenses, a once-in-a-lifetime vacation, certain (rock solid) investments, or even paying off high-interest debt.

“When deciding whether to alter a VA loan using a home equity loan, a HELOC, or a VA cash-out refinance, it’s all about the circumstances,” says Army National Guard combat veteran (Iraq, 2005-06) Jeff Rose, CFP, founder of GoodFinancialCents.com. “It could be a smart move if you’ve got a good chunk of equity in your home and need funds for important stuff like consolidating debt, making home improvements, tackling emergency expenses, or covering education costs.

“However, it’s super important to understand the financial implications and make sure you can handle the extra financial load, as failing to manage the payments could put your home at risk.”

As Rose notes, VA mortgage holders who have piled up substantial equity in their homes have convenient access to funds that can make their big-ticket dreams come true.

Does the VA Offer Home Equity Loans or Lines Of Credit?

Several options exist for VA mortgage holders to turn their home’s equity into spending money, but a VA home equity loan is not among them. The Department of Veterans Affairs does not back, underwrite or support any variety of home equity loan.

Instead, home equity loan options for a VA mortgage include a standard home equity loan, a home equity line of credit (both offered through traditional lenders), or — and here’s where the VA gets into the game — through a cash-out refinancing loan.

Types of Home Equity Loans

Two varieties of loans enable homeowners, no matter how their mortgage is financed, to access equity in their homes. These are home equity loans and home equity lines of credit. While they go by similar names, they have distinct and important differences.

Home Equity Loans

Home equity loans are among the most common methods for borrowing against the equity in your home. Similar to personal loans, but usually with far better terms, the successful home equity applicant receives a lump sum of cash that is paid back over time.

Oftentimes, a home equity loan is referred to as a “second mortgage.”

Pros of Home Equity Loans

The benefits of most traditional home equity loans include, but are not limited to:

• The terms are written in concrete. That is, the length of the loan is set, the interest rate is fixed, the monthly payment does not change. You can accurately forecast the impact of the loan on your monthly budget.
• While not offered by the VA, home equity loans can be used alongside, and with no effect on, your existing VA mortgage.
• At closing, the borrower receives a lump-sum payout.
• Compared to a VA cash-out refinancing, the closing costs on a home equity loan may be significantly lower, especially for borrowers who actively comparison shop; some lenders will waive closing costs altogether.
• If the loan meets IRS guidelines, the interest paid may be deductible on your income tax.

Cons of Home Equity Loans

No financial transaction is completely free of downside risk, home equity loans included. The negatives include, but are not limited to:

• The borrower takes on a second monthly mortgage payment.
• Because the home’s equity secures the loan, you risk losing your home if you can’t keep up with the payments.
• The borrower pays interest on the entire lump sum payout even if the entire sum is not needed or used.
• Fixed loan terms also mean inflexible loan terms; the payment demand remains in force throughout the life of the loan. Be cautious about prepayment penalties if you’d like to get out ahead of schedule.

Home Equity Loan Requirements

When shopping for a home equity loan (or a home equity line of credit), having a sizable chunk of equity is only a start. Other factors borrowers will weigh include:

• The amount of equity in your home. To qualify, you’ll typically need at least 20% (that is, the value of your home in the current market, minus the balance on your VA mortgage).
• A healthy credit score, steady payments on existing credit, and a low debt-to-income ratio.
• Good standing with your current mortgage.
• Income that is demonstrated, reliable, and adequate.

Home Equity Loans of Credit (HELOC)

Like a home equity loan, a home equity line of credit, or HELOC, allows you to borrow against the equity in your home without tampering with your existing mortgage. There are, however, significant differences, including variable interest rates, a draw period (when borrowers can access some or all of their equity limit) rather than a lump-sum payout, and variable monthly payments.

Pros of Home Equity Loans Of Credit

HELOCs can be attractive for a variety of reasons. These include, but are not limited to:

• During the “draw period,” usually five to 10 years, borrowers can access only the equity they need as they need it, limiting the size of the loan and the amount of interest the loan gathers.
• Throughout the draw period, borrowers pay only the interest that the loan accrues. HELOC rates typically start lower than (fixed) home equity loan rates.
• HELOCs act like credit cards during the draw period; paying down the balance frees up your credit limit.
• Interest payments may be deductible if they meet IRS guidelines.

Cons of Home Equity Loans of Credit

Some of the downsides of HELOCs are identical to home equity loans. Others are soberingly different. HELOC negatives include, but are not limited to:

• Borrowers are taking on a second mortgage payment.
• HELOCs put the security of the borrower’s home on the line; defaults can lead, ultimately, to foreclosure.
• Adjustable interest rates can rise.
• The draw period ends at a specified time, usually between five and 10 years. At that point, the borrower is responsible for principal and interest payments that may be breathtakingly high.
• Some lenders offer only balloon payments – large, one-time payments — at the end of the loan. Without ready cash to make that payment, borrowers may have to refinance their HELOC balances.

VA Cash-Out Refinance as an Alternative to Home Equity Loans

Remortgaging your house to take advantage of lower interest rates, lower your monthly payment, access money locked up in your home’s equity or the trifecta (all three!) are all possible in a cash-out refinancing loan.

Bonus: Cash-out refinancing loans are available through the VA’s home loan refinance programs.

Eyes wide open, borrowers. “VA-backed homeowners should approach home equity withdrawals in the same way that non-VA homeowners do,” says Dan Green, CEO of Cincinnati-based homebuyer.com.

“First, look at your current mortgage rate as compared to today’s cash-out refinance rates. Remember that your entire mortgage will convert to the cash-out refinance rate, so if today’s rates are much higher than your current rate, this could be a pricey proposition.

“Conversely,” Green continues, “if your current mortgage rate is much higher than today’s cash-out refinance rates, doing a cash-out refinance can be your least expensive path for meeting your goal.

“If there is no obvious cash-out refinance choice and you’re choosing between a home equity line of credit and a home equity loan, again, I’d look to current interest rates.”

Pros of a VA Cash-out Refinance

Cash-out refinancing loans, especially those backed by Veterans Affairs, have a number of advantages. These include, but are not limited to:

• Depending on when the original mortgage was struck, loan refinancers may be able to lower the rate on their entire mortgage balance.
• With the VA, no mortgage insurance is required, avoiding a potentially hefty monthly premium.
• For qualifying veterans and active-duty military, a VA cash-out refinancing loan can be executed on any type of mortgage; the refinanced loan did not have to begin as a VA-backed loan.
• VA loans allow up to 100% financing, which means it’s possible to access all of the equity in your home.

Cons of Cash-out Refinance

VA cash-out refinancing loans have plenty going for them, but there are potential hazards, including but not limited to:

• Timing is crucial. During periods when high interest rates are high, borrowers may not be able to beat the rate on their current mortgage.
• Borrowers who refinance and keep the same timeline — swapping a 30-year payout for another 30-year payout, even though they’ve been in the home eight years — are certain to pay more overall interest.
• Closing costs on VA loans, including cash-out refinances, typically check in at between 3% and 6% of the total loan balance. VA borrowers also must satisfy a funding fee, generally 2.15% to 3.3% of the loan.
• As Rose, the CFP combat veteran points out, “You can’t roll your closing costs on top of the loan. You’ll need to cover these costs at the closing table, probably using some of the equity you’re cashing out.”

What Is the Best Option for Me and My VA Mortgage?

If one cash-out option was right for every homeowner, VA-eligible included, there probably wouldn’t be so many choices. But variety is the spice of America, just one of the reasons why honorable people choose to defend it in uniform.

Your decision among these several choices will not be achieved without realistically researching your situation, reviewing your needs, your timeline, and your financial goals.

Your pick will be influenced by the same things lenders will review: your credit score, payment history, income, and accrued home equity. Know what you’re getting into before you get into it.

Moreover, consider your status. Active-duty personnel and reservists must factor the possibility of deployments into their calculations.

“Frequent deployments can impact your ability to manage a HELOC or home equity loan,” says Bergen County, N.J.-based Shmuel Shayowitz, president and chief lending officer at Approved Funding.

Consider, also, changes of station, Shayowitz says. “Frequent moves might affect your long-term plans, so refinancing decisions should align with your career timeline.”

To go deeper:

• VA Home Loan Benefits.
• Can You Have Multiple VA Loans?