How and When to Refinance a VA Loan to a Conventional Mortgage

The powerful VA loan benefits available to veterans offer no down payment and no PMI. But as your financial situation changes, refinancing into a conventional loan may make more sense. Whether you want to convert your home into a rental, restore your VA entitlement, or qualify for different loan terms, understanding when and how to refinance from a VA loan to a conventional loan is key.

VA Loan Overview

The Department of Veterans Affairs doesn’t actually lend money. Instead, the VA guarantees a portion of each VA loan made by private lenders (e.g., banks, credit unions, etc.). This guarantee protects these lenders from default. In other words, if a veteran stops making payments on his or her VA loan, the government will reimburse the lender for a portion of the outstanding loan balance.

Due to this protection, lenders face far less risk with these loans. And, they pass this reduced risk on to veterans by offering outstanding terms for VA loans. Of note, VA loans:

• Do not require a down payment.
• Offer extremely competitive interest rates.
• Do not require private mortgage insurance, or PMI.
• Allow for a streamlined refinancing through the IRRRL program.

These advantageous terms lead many veterans to use the VA loan to purchase their first home.

Conventional Loan Overview

While VA loans offer significant benefits, they aren’t the only option. Veterans can also use conventional loans to purchase or refinance a home. Unlike VA loans, conventional mortgages aren’t backed by the government, meaning lenders assume more risk and may require stronger credit, a down payment, or PMI.

Typically, conventional loans make the most sense for homebuyers with high credit scores (at least 740) and enough cash for a 20 percent down payment. They fall into two categories: conforming loans, which follow Fannie Mae and Freddie Mac guidelines, and non-conforming loans, which do not.

Reasons to Refinance from a VA Loan to a Conventional Loan

If conventional mortgages require A) down payments, B) higher credit scores, and C) PMI, why would a veteran want to refinance from a VA loan to a conventional one? Several reasons exist:

• Rental property conversion: Veterans who want to turn their current VA-financed home into a rental property may refinance into a conventional loan to free up their VA entitlement. This allows them to use their VA benefit a second time to purchase a new primary residence.
• Better terms: While VA loans offer competitive rates, borrowers with strong credit may qualify for equal or better terms with a conventional refinance.
• Do not qualify for IRRRL: Veterans who don’t qualify for the VA’s streamline refinance (IRRRL) may need to refinance into a conventional loan to lower their interest rate.

NOTE: Conventional loans require private mortgage insurance (PMI) if you have less than 20% equity. For example, on a $200,000 home, you’d need at least $40,000 in equity (owing $160,000 or less) to avoid PMI. If you’re refinancing to a conventional loan and want to skip PMI, aim for at least 20% equity.

How to Refinance a VA Loan to Conventional (Step-by-Step)

After reviewing the above, if refinancing from your current VA loan to a conventional loan makes sense, here are the steps to do it:

1. Confirm Your Home Equity

While you don’t need to have 20 percent equity in your home to refinance into a conventional loan, you’ll have to pay PMI if you do not. You’ll need to factor these additional payments into your monthly budget. To save money in this step, you can use a home value estimator like Zillow for a rough value. But you’ll still need to pay for a formal appraisal during the refinance loan closing process.

2. Check Your Credit Score

To qualify for the best loan terms, you’ll want a credit score over 740. However, some lenders will allow you to refinance into a conventional loan with a credit score of 620 or higher. If you have a lower score than this, chances are you won’t qualify for any conventional refinance programs.

3. Calculate Your Debt-to-Income Ratio (DTI)

Lenders use the debt-to-income ratio as a measure of a borrower’s ability to repay debt. To calculate it, add up all your monthly debt payments (e.g., car loans, credit card payments, student debt, and your future mortgage payment) and divide them by your gross monthly income. Most lenders will want to see a DTI below 40 percent, though some will allow up to 50 percent.

4. Compare Conventional Refinance Offers

Once you’ve confirmed your financial health in the above steps, you’ll want to actually compare conventional refinance quotes from different lenders. These comparisons will help you decide which conventional refinance makes the most sense for your situation. At a minimum, you should compare: 1) APR (the effective interest you’ll pay on a loan, including fees); 2) closing costs; and 3) loan terms (e.g., 15-, 20-, 25-, vs. 30-year loans).

5. Apply and Close on the Loan

After selecting the best conventional refinance option, you’ll need to apply for the refinance loan. This will include submitting all your financial information, completing a formal home appraisal, and providing any additional information the lender requires. The closing process will be essentially the same as a home purchase closing, except there won’t be a seller involved. You will sign the closing documents with either a settlement agent or a real estate attorney.

6. Request VA Entitlement Restoration (If Needed)

If you refinanced your VA loan to a conventional one in order to use the VA loan a second time, you’ll need to file paperwork with the VA. Specifically, you’ll need to request the one-time restoration of entitlement by filling out a Request for a Certificate of Eligibility, VA Form 26-1880, and sending it to the VA regional loan center for your state.

Final Thoughts

The VA loan provides many veterans with an outstanding option for buying their first homes. But there are situations where a conventional loan makes more sense. And, depending on your situation, refinancing from a VA loan to a conventional one may be a great option. By following the steps outlined above, you’ll be able to do just that.