The Veterans Administration does not require an appraisal for an IRRL refinance loan but does for a cash-out refinance loan. This means that if a veteran is refinancing the original loan amount only, and is not requesting to get cash from the refinance, no appraisal is required. If the veteran is requesting that a second mortgage or credit cards to be paid off with the proceeds of a refinance loan, it is considered a cash-out refinance and an appraisal is required. Cash-out refinances can not be for more than 90% of the new appraised value.
Why are lenders requiring an appraisal for IRRL refinance loans?
The short answer is because they are risky to the lender. The long answer starts off with an explanation that the VA is basically an insurance agency; it insures 25% of the principal loan balance against a veteran's default. The VA collects a funding fee, at loan origination, as the premium to insure that default.
Is it illegal for lenders to require the appraisal for a VA IRRL?
Of course not. Since the VA doesn't lend money but insures the loans, the lenders can superimpose more restrictive guidelines for its VA loan programs. Its the equivalent of wearing both a belt and suspenders to insure that your pants don't fall down.
What's the big deal if the VA insures the loan?
VA loans, originated a few years ago, may substantially more than the existing home valuation. If the existing balance is greater than 25% of the current valuation, the lender is exposed to loss in the event of a veteran default. Let me give you an example:
- veteran buys a home for $400,000, in 2005, with a $408,300 VA home loan (100% of purchase price plus the funding fee).
- the veteran wants to refinance the home loan to a low interest rate but the current value of the property is only $280,000.
- If the veteran were to default on the new loan, the VA would only insure 25% of the loan amount; only $100,000 would be paid to the lender
The default would result in a loss to the lender of at least $20,000. This is why lenders are requiring appraisals for VA IRRL loans. Some lenders don't require an appraisal but charge higher interest rates for VA IRRL refinance loans. Charging a higher rate does two things:
- it dissuades current VA borrowers from refinancing )it doesn't make financial sense)
- it "pads the profit" on this particular loan. An interest rate addition of .375% could result in a 1% "extra" profit to the new lender.
Isn't that profiteering?
Not really. Call it a "user tax" if you wish but the premium pricing, charged for VA IRRL refinance loans without an appraisal, allows the lender to offset the risk associated with default. The VA default rate stands around 5%. This means that 1 in every 20 VA loans results in a default. If the lender makes 20 "risky" VA IRRL refinance loans, one should default. The "extra profit" collected, on the other 19 loans, could offset the eventual loss the defaulted loan incurred.
What should a veteran who can't refinance because of current valuation do?
Find a lender who doesn't require an appraisal for a VA IRRL refinance loans. Compare the rate that lender offers, with the current rate, and analyze whether or not it makes sense to refinance.
