Type I vs. Type II Veterans Affairs Cash-Out Refinance: Key Differences

Did you know that a Veterans Affairs (VA) cash-out refinance has two distinct types? Eligible borrowers who are considering refinancing their VA loan or their non-VA loan into a VA loan should make sure they understand the differences between a Type I and Type II VA cash-out refinance.  

In this article, we will give you a refresh on how the VA cash-out refinance works, the differences between the two types, and important requirements for a VA cash-out refinance.

What is a VA Cash-Out Refinance?

A VA cash-out refinance can help eligible borrowers tap into their home equity for cash, sometimes help borrowers get a lower interest rate, and can be used to refinance a non-VA loan into a VA loan. The cash from a cash-out refinance can be used however the borrower sees fit. Borrowers might use the cash to pay a large expense or build their emergency savings, among other uses.  

When you get a VA cash-out refinance, you are replacing your current mortgage with a larger one. It’s important to note that this can lead to an increase in monthly payments, more money spent on interest over the loan term, and a longer loan term. However, this will depend on your specific financial situation and the terms you qualify for from your lender.

Type I vs. Type II VA Cash-Out Refinance

As we’ve explained, there are two types of VA cash-out refinances:

Type I VA Cash-Out Refinances

A Type I VA cash-out refinance takes place when the new loan amount does not exceed the payoff amount of the loan being refinanced. For example, if you still owe $125,000 on your original loan, and your new VA loan is for $125,000 or less, your loan would fall under Type I. This type of refinance usually has more stringent requirements than the second type.  

Despite technically getting a VA cash-out refinance, the borrower in this case would not take out cash. Most likely, a borrower pursuing this loan type would do so for reasons such as lowering their interest rate. While that could possibly also be achieved through the VA interest rate reduction refinance loan, the Type I cash-out refinance can be used to pay off both VA and non-VA loans.

Type II VA Cash-Out Refinance

When you think of a VA cash-out refinance, you are likely thinking of the Type II version. A cash-out is Type II when the new loan amount is greater than the payoff amount of the existing loan. This loan type can allow the borrower to remove equity from their property and get cash back.

Net Tangible Benefit

A VA cash-out refinance, no matter the type, must meet the VA’s Net Tangible Benefit (NTB) requirements. There are eight NTBs, but each refinance only needs to meet a minimum of one. To qualify for the VA cash-out refinance, your loan must meet one of these criteria:  

1. Mortgage Insurance. The refinance eliminates monthly mortgage insurance payments. 
2. Loan Term Length. The loan term for the refinance is shorter than that of the original loan.  
3. Interest Rate. The refinanced loan has a lower interest rate than the original loan (If the original loan is an adjustable-rate mortgage, the refinance would need to be lower than the original loan’s current rate). 
4. Monthly Payment. The total monthly payment, meaning principal plus interest, is lower after refinancing.  
5. Fixed Rate. The new loan switches the original loan type from an adjustable rate to a fixed rate.  
6. Construction Costs. The cash-out refinance is used to pay off the borrower’s interim construction loan. 
7. LTV. The new loan has an LTV less than or equal to 90%. 
8. Income. The new loan leads to a higher monthly residual income for the borrower.

Seasoning & Recoupment

Whether you are refinancing a VA loan or non-VA loan with your VA cash-out refinance, you must meet the seasoning requirements. Specifically:  

• Your first monthly payment on your original loan must have been made 210 or more days before you close on your refinance 

• You must have made six monthly payments on the original loan. 

• If you are refinancing a loan within a year of its closing, your lender will need a payment history from your loan servicer as proof of payments. 

Additionally, the Type I refinance has a recoupment requirement. That means your lender must certify that the recoupment period for fees, expenses, and closing costs is no further than 36 months from when the loan closes.

Appraisal and Loan-To-Value (LTV)

An appraisal is required for VA cash-out refinances. In this appraisal, an independent appraiser will look at your home to determine how valuable it is and if it meets the VA’s minimum property requirements. The value decided in the appraisal plays a key role in determining how much equity the borrower can access for cash.   

There are also LTV requirements. The VA will not guarantee a cash-out refinance with an LTV over 100%, which includes the VA funding fee if it was financed into the loan. You can calculate LTV by dividing the total loan amount by the appraised value of the property.  

So, for example, if you’re seeking a loan worth $350,000, but your home is appraised at $325,000, you would have an LTV of 108%. The VA would not be able to accept that LTV.

When to Choose Type I vs. Type II

Which loan type you ultimately decide upon depends entirely on your financial situation and conversations with your lender. With that said, there are some reasons why one might go with a Type I VA cash-out refinance instead of a Type II VA cash-out refinance.  

You might choose Type I if your primary goal is to reduce your monthly costs by, for example, potentially getting a lower interest rate.  

You might choose Type II if you have a large expense that you are hoping to finance, such as debt consolidation, renovations, education costs, or other needs. If you get a Type II cash-out especially, it’s important that you feel confident potentially managing a larger monthly payment moving forward.

Final Thoughts

If you’re an eligible veteran borrower considering refinancing your loan, it’s good to know the differences between a Type I and Type II VA cash-out refinance. Your loan type ultimately depends on your financial situation, goals, how much equity you have available, and the terms of your lender. Hopefully, this article gave you some clarity heading into those conversations with your lender!