Back to Basics-VA Interest Rate Reduction Refinance Loans (IRRRL)

This article was suggested to me by a long-time shipmate & colleague (thanks, Dave!).  Over my life, I’ve refinanced several times using an IRRRL, when it made financial sense for me to do so.  However, it wasn’t until I got this question that I thought about researching it a little more for an article.  Hopefully, this article will achieve a couple of things:

  • Provide some information without dangling a mortgage-application process in front of your nose (I hate learning about how something works from someone who has something to gain from it)
  • Give you some perspective beyond what the VA’s website tells you.  It’s good information, but not all of it is accurate.  Also, sometimes it helps to have a real-life example or two.  That way, you can make your own decision based upon the facts in your own financial situation.

Introduction-What is a VA IRRRL?

According to the VA’s website, the VA Interest Rate Reduction Refinance Loan (IRRRL) “lowers your rate by refinancing your existing VA home loan.”  Well….kinda, but only in a decreasing interest rate environment.  I wouldn’t go off-track so quickly, but it’s the first sentence on the VA’s webpage, so I need to address this point.  For example, if your current mortgage rate is 6%, and prevailing VA mortgage rates are at 4%, then yes—you’re able to lower your rate by refinancing with an IRRRL.  However, if your mortgage is 3.5%, and current rates are at 4%, you’re not going to save anything.  But I digress.

A VA IRRRL is simply a streamlined process that allows you to cut a lot of red tape when refinancing your existing VA mortgage.  For example, you don’t have to have an appraisal or re-do the underwriting that was done with your VA mortgage.  Also, you can do a VA IRRRL without any out-of-pocket costs.

However, there are limitations.  First, you can only do a VA IRRRL on an existing VA loan.  Kind of makes sense when you think about it, since it’s a streamlined refinance.  Also, you cannot take cash out during an IRRRL, so if you’re looking to tap into your home equity, you won’t be able to do so with an IRRRL.  Finally, unless you meet the VA’s exemption criteria, you do have to pay a VA funding fee.  People who are exempt include:

  • Veterans receiving VA disability compensation
  • Veterans who would be receiving VA disability compensation but are currently receiving retirement or active-duty pay
  • Surviving spouses of veterans who died in service or from a service-related disability

If you do have to pay a funding fee, you should know that the fee is only .5% of the loan balance, vice 2.15%-3.5% for regular VA refinances (with cash-out option).

When you refinance with an IRRRL, you pay .5% as the VA funding fee. Normal VA refinances range from 2.15% to 3.3%

The difference between an IRRRL & regular refinance fees

When is a VA IRRRL good for me?

A VA IRRRL is great when you can lower:

  • Interest rate
  • Monthly payments
  • Length of your mortgage
  • All three (see my story below)
  • If you’re looking to go from an ARM to a fixed rate loan (this might be worth it, even if there’s a modest increase in your interest rate).

Although this will most likely happen in a declining interest rate environment, it might be possible to lower your monthly payments OR to shave a couple of years off your mortgage in a static market.  Of course, marketers know this, and try to bombard people with literature to get them to refinance, especially if interest rates are expected to go up.

Also, you should probably have a reasonable expectation that you’re going to use the residence for a while.  There’s not really a hard & fast rule here, but you should at least figure out how to calculate the payoff period.

Calculating the payoff period

The payoff period is the amount of time it takes for you to ‘recoup’ the closing costs of your new mortgage.  Most people determine this by figuring out the cost savings of their new mortgage, then figuring out how many months it will take for the cost savings to outweigh the closing costs.

For example, Jack & Jill get a new mortgage.  Closing costs are $5,000 (including funding fee).  They figure to save $200 on their mortgage.  In this case, it would take Jack & Jill 25 months ($5,000/$200) to break even on their new mortgage.  If they hold this property for longer than 25 months, then they will have at least paid off the closing costs.  If they expect to sell their house within 25 months, they might want to think twice about the refinance.

While this is important for homeowners, it’s especially important for landlords or people who expect to become landlords.  While the monthly cost savings might help you break even, it might not be worthwhile if you plan to sell your rental property.

Of course, this doesn’t work if your mortgage ends up being higher than previously.  In that case, you might want to consider the reasons why you’re looking into the refinance.  Shaving a couple of years off your mortgage might sound great, but not if your monthly cash flow can’t support the new payments.

If you qualify for a waived VA funding fee, you can expect your payoff period to be lower than it otherwise would be.  But run the numbers to check.

When should I not go for a VA IRRRL?

If you can tell that an IRRRL makes sense, then you should go for it.  If it doesn’t make sense, then you shouldn’t.  But you should do the math for yourself.  That doesn’t mean that IRRRLs are either good or bad.  They can either:

  • Enable a great decision, as mentioned above
  • Turn a borderline decision into a decent decision (lower costs might make it worthwhile)
  • Enable a poor decision (if the numbers don’t add up)

Don’t let people pressure you into taking advantage before you ‘lose an opportunity.’  Hogwash.  You should only refinance if the numbers work.

Here are some situations where the numbers probably won’t work:

  • You’re looking to hold the property for less than the payoff period.
  • You don’t save any money on the mortgage payments
  • You are looking to refinance to a shorter term loan, but you haven’t held the property for that long.
  • If you’re looking for a cash-out refinance. In that case, you wouldn’t be able to do an IRRRL.

There really isn’t a ‘tell-all’ rule.  Run the numbers, and let them help you make the decision.  If you need help, a fee-only financial planner can help you do this.

Forrest’s VA IRRRL Story

In 2002, Tania and I bought our first house, in Norfolk.  Our first interest rate was 6.71%.  A few years later, we’d refinanced to 5.5%…good, right?  Fast forward about 8 years (and 5 PCS moves).  Mortgage rates had gone down (but not to the bottom), and it was a good opportunity to refinance.  Also, we’d been paying down on our mortgage for 8 years, so we had a decent amount of the loan paid off.

We decided to refinance to a 20-year loan, at a lower rate of 4.25%.  This gave us a lower monthly payment, and shaved about 2 years from the payoff!  This refinance allowed us to get all three goals:  lower payment, lower interest, and shorter mortgage term.  Great!

Of course, this was a combination of factors:

  • Decreasing interest rates. I don’t see this happening too much more often, after a historic 30+ year run on interest rates.
  • 8 years of paying off the previous mortgage. Having 22 years left on the mortgage, it wasn’t too difficult to make the move to a 20 year one.
  • Having a lower balance. Another benefit of having only 22 years left on the mortgage—we had a lower balance to refinance.  This allowed us to have lower monthly payments.

Not all of these will be true for you.  But if one or more of these might apply to your situation, it might be worth running the numbers to see.

Conclusion

Deciding to refinance your existing loan can be a challenge.  An IRRRL is a way to simplify that process.  However, the decision to pursue an IRRRL should be made in the context of the greater decision on whether to refinance at all.  While an IRRRL can help enable a refinance, your judgment is the best way to determine whether it’s a good decision for you.

What do you think?  Feel free to post your VA refinance ‘success stories’ in the comments section below, or join the Military in Transition Facebook Group!

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About Forrest Baumhover

Forrest Baumhover is a Certified Financial Planner™ and tax professional. His firm, Westchase Financial Planning, focuses on the unique financial planning needs of servicemembers and families looking to separate or retire from active duty.If you’d like to learn more about Forrest or his services, please check out the About Forrest page at the top of this article.
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