VA Cash-Out Refinance: How It Works

What is a VA cash-out refinance?

A VA cash-out refinance loan replaces your current mortgage with a loan backed by the U.S. Department of Veterans Affairs and gives you the option to turn home equity into cash. You can use the cash for any purpose, such as home improvement projects or paying off high-interest debt.

Another type of VA refinance loan is the VA Interest Rate Reduction Refinance Loan. It's also known as a VA streamline refinance because a VA appraisal isn’t always required and the lending process is simplified, which saves time and fees. You can't refinance a conventional loan or take out cash with a VA streamline refinance.

» MORE: VA loan basics for active-duty military and veterans

How a VA cash-out refinance works

The process for a VA cash-out refinance is similar to getting a VA purchase loan. You'll apply through a bank, mortgage company or credit union that offers VA loans, and to qualify, you'll need a VA certificate of eligibility, which shows that you meet the military service or surviving spouse requirements.

The home you're refinancing must be your primary residence. The lender will hire a VA-approved appraiser to estimate the home's market value and ensure it meets VA minimum property requirements. You may be able to borrow up to 100% of the appraised home value, but this varies by lender.

The lender will also check your credit and debt-to-income ratio. Each lender sets its own minimum credit score for VA loans. These minimum FICO scores are typically in the low- to mid-600s, but may be higher if you want to cash out all your home equity. Lenders will also look at your credit history to determine if it’s satisfactory.

The VA prefers a debt-to-income ratio of 41%, but a lender will consider a borrower's overall ability to repay the loan and may approve an applicant with a higher DTI.

» MORE: Browse top mortgage refinancing lenders

VA cash-out refinancing costs

Closing costs are the myriad fees you pay for a mortgage, such as the loan origination fee, fees for appraisal, title insurance, taxes and other charges. Closing costs typically range from about 3% to 5% of the loan. You must pay these costs at closing for a VA cash-out refinance — you can't roll them into the new loan — but you can use some of the extracted home equity cash to cover them.

In addition, most borrowers will pay a VA funding fee. The funding fee for VA cash-out refinancing is 2.3% of the loan amount if this is your first VA loan and 3.6% if you've had a VA loan before.

VA cash-out refinance tips

• Refinance only if the potential savings and benefits outweigh the costs. NerdWallet's mortgage refinance calculator can help.

• Lender credit requirements and mortgage rates vary, so shop around to get the best deal.

• Using a cash-out refinance to pay off high-interest credit card debt or fund home improvements can be a sound strategy. But avoid extracting cash from your home to pay for vacations, new cars or other items that offer no return on your money.

» MORE: Cash-out refinance pros and cons