IRRRL: What Homeowners With VA Loans Should Know About Interest Rate Reduction Refinance Loans
From conventional loans to FHA loans, USDA loans, and more, there are a number of home mortgage options for people of different walks of life. There are many different loan types, and some government organizations guarantee mortgages to suitable applicants. For veterans of the United States military, the Department of Veterans Affairs (VA) offers an exclusive home loan option with benefits not available to the broader population.
After homeowners with a VA mortgage have owned the home for some time, they may decide that they want to refinance the loan. There are several ways that they can do this. A VA Streamlined Refinance, also known as an Interest Rate Reduction Refinance Loan (IRRRL), is a popular refinancing loan created by the VA in the 1980s to simplify the process of securing a new loan with better rates.
Although homeowners with VA loans can choose to refinance to a conventional loan or one backed by the Federal Housing Administration (FHA), there are many reasons that they might prefer an IRRRL. Applying for a refinance loan is much like applying for a mortgage to buy a home, with the same income, credit, appraisal and underwriting requirements. Similar to how the VA home loan offers an easier qualification process for prospective buyers than a conventional mortgage, the IRRRL has less stringent requirements than a conventional refinancing.
With a thorough understanding of various aspects of the IRRRL, including its benefits and possible concerns, homeowners can make an informed decision about refinancing their mortgages.
For informational purposes only. Always consult with a lender or financial advisor if you have specific questions before proceeding with significant financial decisions.
Table of Contents
- The IRRRL Process Step-by-Step
- 1. Requirements and Application
- 2. What Happens to the Current Loan?
- 3. The New Loan and Associated Fees
- Pros & Cons of an IRRRL
- Understand the IRRRL: Example Scenarios
- Scenario 1: In for the Long Haul — Lower Monthly Payments
- Scenario 2: Shorter Term — Lower Interest Rates & Higher Monthly Payment
- Scenario 3: Selling Soon — Fees Outweigh Short-Term Savings
- Protecting Yourself From “Churning”
- Tips for Making an Informed Financial Decision
- IRRRL Facts, Guidelines, and Resources
The IRRRL Process Outlined Step by Step
1. Application (and Requirements)
One reason many people with a VA loan choose to pursue an IRRRL is that the application process can be much less complicated than applying for a traditional refinance loan. A typical refinance requires most of the paperwork of a new mortgage, including verification of income, debts, credit and the value of the home. An IRRRL does not base a person’s ability to secure the loan on these factors. As such, lenders may be willing to offer such a loan to qualified applicants with this documentation:
- Proof that the current loan is a VA loan and is at least several months old
- On-time payment history for the past year
- Evidence that they live or have lived in the home as a primary residence
- Verification of funds for borrowers who intend to pay cash for closing costs
- Interest rates that are lower than the rate on the existing loan, unless the applicant is converting from an ARM to a fixed-rate mortgage
Since the IRRRL does not go through a typical underwriting process, lenders are not obligated to verify income, check a person’s credit, or get an appraisal to see the home’s current value. Some lenders will obtain a credit report and require an appraisal as part of their own processes. Since all IRRRLs come from existing VA loans, applicants do not have to provide a certificate of eligibility (COE). The lender can simply verify with the VA that the person was eligible when they got the original loan. A simpler process means that the loan may require less work from the borrower and take less time to close.
2. What Happens to the Current Loan?
Knowing what happens to the existing loan after a refinance can help put applicants at ease. Lenders have a streamlined process for closing on one mortgage and paying off the original loan. The government sets specific guidelines for how and when the new loan should be recorded and the time it takes to pay the remaining balance on the old one.
During the application process, the lender asks for a payoff amount from the organization that holds the current loan. The payoff total depends on the amount of interest currently due, as well as the principal and any fees. The estimated closing date for the refinance is important. A loan closed at the beginning of the month will have fewer days of interest accrued than one in the middle of the month.
After closing on the new loan, the lender generally takes the loan information to the county recorder. Within a few days of this task’s completion, the holder of the current mortgage receives the payoff amount. The payment usually comes in the form of a wire transfer, handled by the lender.
Many people have an escrow account used to pay for property taxes and homeowners insurance. When the old loan is paid off, the escrow account for that loan is closed. The money left in the account is refunded to the borrower. The total varies depending on the time of year and how recently the account holder paid taxes or insurance. This can take up to a few weeks to process and send the money. If homeowners have not received it within a month, they may want to follow up with their old mortgage servicer to check the status.
3. The New Loan and Associated Fees
Before borrowers can assume the new loan, they must close on the existing one. People considering an IRRRL may need to pay some or all of the following closing costs:
- Origination fee to cover the lender’s processing expenses
- Credit report and appraisal, if required by the lender
- Discount points to lower the interest rate
- Title and recording fees
- Interest to cover the remainder of the month
- Advance payments into an escrow account for property taxes and homeowners insurance
- VA Funding Fee
Borrowers are usually not obligated to pay cash for these costs at closing. Instead, they can choose to wrap the costs into the loan as a benefit provided by the VA. The lender may also offer to pay all closing costs in exchange for a marginally higher interest rate. If applicants take this route, they must confirm that the new interest rate will still be lower than the old one.
The VA Funding Fee varies depending on the type of loan a person is applying for. When people use a typical VA loan to buy a home, they generally pay a 2.15 percent funding fee. Since an IRRRL is not considered a separate use of this entitlement, the fee is lower. Most IRRRL applications carry a charge of 0.5 percent of the loan amount, unless the applicant qualifies for a waiver or fee refund.
The principal on the refinanced loan may not equal the payoff amount for the old loan. If the lender puts the closing costs into the new mortgage, the principal may be higher than it was when the prior loan was paid off. Homeowners should keep this in mind when they make a decision about how to approach closing costs. Paying cash can help to minimize the principal on the new loan. However, applicants may need to provide a few months of bank statements to verify that the funds used for closing did not come from a loan.
Pros & Cons
With any loan, homeowners need to be sure that the process is right for them. Even if the loan contains a number of potential advantages, people need to weigh the benefits and disadvantages before making a choice. Homeowners may want to look at the IRRRL in the lens of a broader plan to refinance. If they could qualify for other types of refinance loans, they can compare various aspects of each type to help them make a decision.
The IRRRL is designed to help homeowners with VA loans secure a lower interest rate, lower monthly payment or pay off the loan faster. As such, many people find that the pros of an IRRRL outweigh the cons. Understanding the limits of the IRRRL completes a full picture of the loan, allowing people to decide if it is a good choice for them right now.
The primary goal that most homeowners want to achieve with a refinance is a better loan arrangement. People with an ARM might want to switch to a fixed-rate loan that gives them the security of a predictable monthly payment. Homeowners with a loan at a higher interest rate could save hundreds or thousands of dollars a year by refinancing to a lower rate. Lowering the rate might give people the opportunity to negotiate a shorter term that allows them to pay off the loan more quickly. Although almost any refinance loan could offer these benefits, the IRRRL sets a requirement for many of them. People who apply for an IRRRL can expect the following advantages for this type of loan:
- Makes it easier to shop for better loan terms with a new lender
- Requires minimal documentation
- Allows homeowners to lower their interest rate, even if they might not qualify for other types of refinance loans
- Permits up to $6,000 in additional financing for energy-efficient upgrades completed within 90 days of closing
- Can be done even if the existing mortgage is worth more than the home
- Limits the total closing costs applicants have to pay and allows them to be rolled into the loan
- Does not require income verification, credit checks, or debt evaluation
- Does not require appraisal of the home’s value or for the value to exceed the loan principal
Living in the home as a primary residence makes the IRRRL process easier. However, homeowners who were relocated as part of their military service may be able to bypass this requirement by proving that the property was once their primary residence. Interested applicants should consult with the lender for specific limitations.
In exchange for limited requirements for qualification and documentation, the IRRRL sets specific guidelines for the way the loan can be used. This refinance may not offer the same kind of flexibility that others do. For example, the IRRRL:
- Might not work for homeowners with loan interest rates close to or lower than current rates
- Requires possibly thousands of dollars in closing costs, which could take years to recoup
- May extend the final payoff date of the loan, if the new term is not shorter
- Does not permit borrowers to get cash out to pay other bills or make most home improvements
- Requires adherence to strict terms set by the VA in exchange for the greater financial flexibility
- Does not permit an increase in interest rate (unless shifting from a fixed-rate to an adjustable-rate mortgage)
- Does not permit a higher monthly payment (unless shortening the loan term)
Since this loan does not force lenders to verify ability to pay the loan, homeowners should evaluate whether or not taking a shorter term is right for them. Switching from a 30-year loan to a 15-year loan could significantly increase the monthly payment. This is one of the few instances in which people can access the IRRRL even if it raises the monthly payment. Additionally, people who are already struggling to meet their current mortgage should evaluate their ability to make the higher payment. Without a guaranteed income and debt verification, lenders may not be able to advise homeowners on the best course of action.
Ultimately, homeowners need to look at their future plans for the home. If they are not sure they are going to remain in the home, or they intend to sell within a few years, the closing costs may outweigh the decrease in monthly payment. With rare exceptions on the funding fee, closing costs are not refundable.
Understanding the Math and Implications of Getting an IRRRL: Example Scenarios
Since the refinancing process is different for everyone, understanding how it might play out for particular loans is important. IRRRL approval depends heavily on interest rates. This means that someone who secured a rate at a historically-low point may find it difficult or even impossible to get an IRRRL on that basis alone.
For people who are likely candidates for an IRRRL, exploring a few possible scenarios can help them see what benefits they might receive, and which pitfalls they may need to avoid. These examples are just a few of many paths that homeowners could take. They outline how a person’s unique application might change the wisdom of applying for an IRRRL, or the limits they face during the process. Doing research and asking questions of each prospective lender will make it easier for homeowners to flesh out the details that are most relevant to their own situations.
Scenario 1: In for the Long Haul – More Affordable Monthly Payments
Oscar has lived in a handful of cities during his military service, but has finally found a place he wants to call home. He has a reasonable certainty that he will be able to stay in the area for the remainder of his career, so he bought a home in Broadmoor a year ago to help meet his financial goals. His original loan was a 15-year fixed. Now that he has made a year’s worth of payments, he wants to find a way to lower his monthly expenses.
A 15-year loan has a much higher payment than a mortgage with a longer term. Lowering the payment would free up hundreds of dollars a month for Oscar to put to various purposes. He wants to start investing some of the remainder into a few different stocks and funds to support his retirement. He also needs more room each month to pay for minor upgrades he wants to make on the property. Oscar understands that it will take years longer to pay off the loan. He thinks the flexibility in the present will make up for the difference.
Oscar knows that an IRRRL only allows him to extend the term by 10 years, to a 25-year loan. Interest rates for 15-year loans are typically lower than longer ones, so he has to consider how he can get a 25-year mortgage with a lower rate. Oscar decided to pay discount points on the loan to lower the interest rate below what he currently pays. IRRRL limits the amount of discount points that can be rolled into the loan to 2 percent of the loan. To drop the interest rate enough, Oscar chose to pay more points and bring some cash to closing to cover it.
Scenario 2: Shorter Term, Lower Interest Rates, but Higher Monthly Payment
Mike is starting to make a plan for what he wants to do after his military retirement. He bought a home near a Colorado Springs military base three years ago with a 30-year fixed-rate loan. He is looking forward to new opportunities once he is eligible to retire and collect his pension. Mike would rather spend as little of that time as possible paying a mortgage. With an increase in his household income since he purchase the property, he realizes he can handle a higher monthly payment. That would make it easier to pay off the loan much sooner.
When Mike bought the house, he secured a reasonable interest rate for the loan. Since 15-year mortgages can have a rate as much as 1 percent lower than 30-year loans, it is unlikely that the current interest rates for shorter loans will be higher than what he is already paying. He knows that paying a lower rate in less time will mean that the loan will cost him much less in interest once it is done. He also likes the idea that he will accrue equity in his home more quickly, in case he decides to sell it a few years from now.
As Mike started to explore this idea, he made a list of his family’s finances and made sure that they could afford the higher bill. Since the monthly payment will increase by more than 20 percent, his lender asked him to provide income verification. Although lenders are not required to ask for income information for most IRRRLs, they are instructed to ask for it in cases like this. Mike is ready to pay hundreds of dollars extra per month for the shorter loan, but not everyone’s income can reasonably accommodate it.
Scenario 3: Selling Soon – Not Recouping Fees
Charlie has owned his home for several years, and completed an IRRRL five months ago. He was able to secure a lower interest rate and cut his monthly payment by about $150. Recently, his circumstances changed, requiring him to sell the home and move. Like many people, Charlie decided to roll the closing costs into the loan. This made it easier for him to avoid having to pay a lot out of pocket for the IRRRL, but increased the amount of the loan by around $5,000.
Charlie has enough equity that he can sell the home without having to treat it as a short sale or lose too much in potential profit. However, he has not yet paid down the principal to cover the lender fees, discount points, and VA funding fee he paid for the IRRRL. Although the refinance shortened his monthly payment, he is not able to keep the home long enough to balance out the total costs.
People like Charlie should consider all the possible factors before making a decision. Sometimes, it is better to keep the loan as it is than rush through a refinance without careful planning. Homeowners who think they may have to move within a year or two may want to wait until they are more aware of their needs before applying for an IRRRL. This is particularly true for those who only have a small share of equity in their homes, or who owe more than the home is worth. Adding thousands of dollars in principal might take years to pay off. People who need to sell the home too soon after refinancing will lose at least some of the potential profit due to the higher principal.
Protecting Yourself From “Churning”
The potential for misuse of the IRRRL system means that homeowners with VA loans need to be vigilant in protecting their own interests. The ease and minimal documentation of the IRRRL makes it an ideal format for unethical parties to engage in a practice known as “churning.” This term describes the repeated use of refinancing as a way to secure payments to the lender in the form of closing costs. Since these fees usually get wrapped into the loan, borrowers may not realize the extent to which the size of their principal keeps growing with each refinance.
The reason people who go through an IRRRL can be even more susceptible to this kind of scam is that the IRRRL does not call for an appraisal or many other common underwriting requirements for approval. This means that homeowners who refinance over and over again could lose a significant portion of the equity in their homes without noticing how much value they have lost.
All IRRRLs have to benefit the borrower with a lower interest rate or monthly payment, but there are several unethical paths people might take to achieve it. For example, a lender might lower both rate and payment by converting a fixed-rate loan to an ARM. Once the initial term is over, though, the borrower could be left with a much higher payment. Ensuring that the IRRRL will provide a definable benefit in relation to the fees helps homeowners avoid the scam.
Red Flags to Watch Out For
Lenders who churn refinance loans can be very difficult to distinguish from other lenders. Until they are caught, the format of the refinance may look basically the same. The only difference is that the loan itself benefits the lender far more than the borrower. Homeowners should look for these common warning signs of a scam:
- Calls or advertisements to consider an IRRRL a few months after completing one
- Sales tactics that focus on borrowers losing an opportunity they will never receive again
- Requests to provide personal identifying information via phone or email
- Interest rates far lower than the average, which may be false or go with a loan that has less favorable terms
- Terms that are not allowed under an IRRRL, such as skipped mortgage payments or cash back
- Efforts to conceal details about closing costs or make them harder to understand
Homeowners should always ask for clarification on confusing parts of the process, and confirm that the loan benefits outweigh the disadvantages.
What Should Be Disclosed
Once people have closed on a loan that meets IRRRL standards, they may have little recourse against predatory terms. This is why homeowners need to read every document carefully for signs that the loan is not in their best interest. IRRRLs feature the same Loan Estimate and Closing Disclosure that other mortgages in the U.S. are required to have. The VA also uses an IRRRL Worksheet to help applicants understand the relevant details of each loan they might consider. As homeowners read this information, they should look for ways the new loan is different from the current one:
- Changes in loan type (e.g. ARM to fixed-rate)
- Differences in loan term, such as a 15-year mortgage converted to 25 years
- Extra costs added (i.e. discount points) to meet IRRRL’s interest rate requirements
- Time and number of payments needed to recoup the fees
This investment of time will help homeowners decide if the loan assists their financial goals more than the lender’s.
Tips for Making an Informed Financial Decision
Ultimately, homeowners - no matter what community they bought a home in - are on the hook to pay for the loans they get. This means that even if a loan does not offer ideal terms, the person who signs the paperwork to close on it is obligated to meet the requirements. This is why experts always recommend that homeowners:
- Pay close attention to any information received during the process
- Ask for all offers in writing
- Have a spouse, trusted friend, or relative give a second look to the details
- Request clarification for anything that does not make sense
- Get copies of every document signed for later reference or comparison
- Shop around to multiple lenders to get the best terms
- Avoid offers that require payment in advance
- Keep in mind that no one is required to accept a loan, even on the closing day
Although many homeowners will eventually refinance their mortgages to allow them to lower their monthly payment, pay less interest, or adjust their loan term, this is not a required practice. People do not have to refinance if the time is not right for them, even if they stand to save a lot of money from the transaction. Lenders who push homeowners to apply for a loan even when they express concerns about it may not be trustworthy.
IRRRL Facts, Guidelines, and Resources
Finding the right lender for an IRRRL starts with the correct information. These links provide useful details about the limits and benefits of the IRRRL program.
Applying for any kind of refinance loan can require the same kind of attention that homeowners put in when they originally applied for a mortgage to buy the home. An IRRRL for qualified borrowers with a VA loan could streamline the process, making it easier to save money on monthly payments or interest paid over the life of the loan. Since the IRRRL has so few documentation requirements, it can be an effort that takes less time and is more likely to succeed.
This difference in documentation requirements comes with limits that homeowners need to understand before they make the application. It also makes this loan type more attractive to unethical people who might push homeowners into an unfavorable mortgage. Careful research and a better understanding of the loan will help homeowners determine if applying for an IRRRL is a good decision for them.