VA Interest Rate Reduction Refinance Loans (IRRRL) Case Study

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… kind of, but only in a decreasing interest rate environment. 

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.

If your mortgage is 3.5%, and current rates are at 4%, you’re not going to save anything. 

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

You will usually have to pay a funding fee with a VA IRRRL, but you should know that the fee is only 0.5% of the loan balance versus 2.15-3.3% for regular VA refinances (with cash-out option).

A VA IRRRL is excellent when you can lower:

• Interest rate
• Monthly payments
• Length of your mortgage
• All three
• 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 a hard and fast rule here, but you should at least figure out how to calculate the payoff period.

Calculating the Refinance 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 crucial 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 before the refinance. 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 choice (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.” 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.
• You’re looking for a cash-out refinance. In that case, you wouldn’t be able to do an IRRRL.

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.

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 the right decision for you.