The IRRRL program provides a very flexible way for veterans to lower their interest rate on a VA loan. With no credit requirements or need to verify your income, it is an easy way to refinance your VA loan. What if you want to reduce your mortgage term with an IRRRL? Is this possible? In many cases, it is possible. The VA only limits how much you can extend a loan term with this refinance program. For example, if you currently have a 15-year program and want to lower your required payments, you could only extend the term 10 years. This means a 30-year program is not an option. However, if you want to reduce your term, you may be eligible. There are some things to consider before you decide to go this route, though.
A Higher Payment
The most concerning thing to consider when you wish to reduce your mortgage term with an IRRRL is the new payment. Chances are it will be higher than your current payment. This is especially true if you refinance from a 30-year loan to a 15-year loan. You literally knock the term in half. This means the principal amount of the loan needs to be paid in half of the time. This translates into a much higher monthly payment. When you decide to lower your term, you have to consider the following things:
- The new interest rate – The ideal situation is to lower your rate at least 2 points when you reduce your term. This way the savings on interest counteracts the increase in principal you have to pay.
- The closing costs – Every loan has closing costs unless you secure a “no closing cost loan” with the lender. No closing costs mean a higher interest rate, though, which could derail your efforts to save money. If there are exceptional closing costs and you wrap them into your loan, it could drastically increase your monthly payment.
Shopping around can help minimize the effects of a high-interest rate and/or high closing costs. Every lender has a different threshold for risk and different costs they charge. Compare the offers from different lenders in order to find the most affordable option for yourself.
Your Debt Ratio
The VA does not require lenders to calculate a new debt ratio for the VA IRRRL program. However, some lenders go ahead and do so anyways. This may be the case if you reduce your mortgage term drastically. The lender might want to make sure you can afford the new payments or they put themselves at risk for default. This may mean the lender will verify your income and current debts. Even if they don’t pull your credit, just the act of determining your front-end debt ratio can make or break the deal. The VA does not have specific debt ratios you must fall into, but the lender you choose might. They want a reasonable amount of your income left over each month. They may not make you fall into conventional debt ratios of 28% on the front-end, but they may restrict how high they let the ratio go.
Will you Stay in the Home?
The length of time you plan to stay in the home will help you determine if you should reduce your term. Any new loan, no matter the term, carries a large part of the interest costs up front. If you look at an amortization table for any mortgage loan, you will see the first few years’ worth of payments cover mostly interest. Yes, you pay a little principal, but not enough to make a dent in what you owe. As time goes on, the principal becomes a larger part of the mortgage payment. If you do not intend to stay in the home until you hit that point, though, refinancing might not make sense. Before you jump into a refinance to lower your term, consider when you think you will move. Is this your forever home until something changes? Maybe you already know you will move in 5 years or less. These are things to consider before refinancing, as it could be a costly mistake for you if you move too soon.
Reduce Your Mortgage Term or Make Extra Payments?
Before you decide to refinance to reduce your mortgage term, take a look at another option. You can always make extra payments towards the principal. You are generally free to make extra payments whenever you want. A great habit to get into is to make one additional mortgage payment per year. You can do this all at once or break it up into 12 equal payments. For example, if your principal and interest equal $1000, you can make a lump sum payment at some point during the year or you can pay $83.33 extra on each mortgage payment to equal that amount. You may knock several years off your term just by taking this simple step. This way you have a lower required payment should you have financial difficulty and are not able to make the extra payment. If you refinance, your minimum payment becomes higher and you have to pay it or face the consequences.
The decision to reduce your mortgage term is a personal one. The VA IRRRL program does allow it, but you may face additional requirements from your chosen lender. Generally, the VA IRRRL program requires very few qualifications. As long as you make your mortgage payments on time and have no more than one 30-day late payment in the last year, you will likely qualify. If you lower your term, though, you provide the lender with additional risk, which may trigger them to look into your financial life a little more. Before you apply, make sure your financial affairs are in order just in case a lender wants to pull your credit or verify your income in order to ensure that you can afford the higher payments that result from lowering your term.