What Is A Tangible Net Benefit?
Kevin Graham9-minute read
August 20, 2020
There are a few reasons a homeowner might choose to refinance their home. These include lowering their rate and/or changing the term of the loan, taking cash out for an investment or renovation or doing a debt consolidation.
Of course, home financing is complicated, and you want to make sure you’re getting a deal that’s in your best interest when you apply to refinance. To that end, lenders must make sure the refinance accomplishes one or more tangible net benefits for the client. This serves as a safeguard against predatory lending practices.
Tangible Net Benefit, Defined
A tangible net benefit (alternatively referred to as a “net tangible benefit”) can be thought of as the advantage a client gains by refinancing. When you refinance your mortgage loan, you’re taking on a completely new loan, so many states and even the federal government require there to be a defined benefit for you in many cases.
In one form or another, there has to be a tangible net benefit to any refinance you undertake if you’re a resident of states with these types of homeowner protection laws on the books, or if your loan is backed by certain federal agencies like the Department of Veterans Affairs or Federal Housing Administration.
The only time you might not have a tangible net benefit is if you’re not in one of the covered states and a federal agency doesn’t cover your loan.
In practice, this is a rarity because if the lender does business in any covered state or sells any federally backed loans, it’s very difficult to maintain a policy that’s not uniform. Additionally, any decent business will put the client first so they can engender goodwill and get repeat business down the line.
What Counts As A Tangible Net Benefit?
Now that you know the theory behind a tangible net benefit, the question then becomes what constitutes a benefit for the client. In this section, we’ll go over several ways a loan can pass the test.
Of course, any test reflects the examiner. Depending on the type of loan you’re getting, the applicable regulation could come from the state you reside in or a federal agency. In many cases, lenders such as Quicken Loans® have their own standards. Again, any lender worth giving your business won’t take advantage of you.
Moving From An ARM To A Fixed-Rate Mortgage
The first instance where refinancing would have a tangible net benefit would be switching from an adjustable rate mortgage (ARM) to a fixed-rate mortgage. The idea here is to get rate security, but to truly understand the benefit, let’s briefly touch on the mechanics of an ARM in comparison to a fixed-rate loan.
The benefit of ARMs is that they employ a concept called the teaser rate for a period – usually 5, 7 or 10 years – at the beginning of the loan term in which you can (likely) get a rate slightly lower than you could on a fixed-rate mortgage for the same 30-year term.
We say likely because there are rare instances such as the low-rate environment we find ourselves in now where fixed rates may be lower than the adjustable ones, but for the purposes of this article, let’s assume the rate is lower.
The reason investors can offer a lower interest rate is that once the teaser period is up, the rate can adjust based on an index added to a margin to be more in line with current market conditions. It can go up or down.
In the case that an ARM goes up, it can’t go up indefinitely as caps are built into the contract. There’s an initial adjustment cap and then a cap for each subsequent adjustment. Finally, there’s a lifetime cap. Here’s a quick example:
Let’s say you’re looking at a loan advertised as a 7/1 ARM 2/2/5. The first part means the rate stays fixed for the first 7 years of the term with adjustments once per year after that denoted by the one.
The part after ARM is the caps. In this case, the rate can rise no more than 2% on the first adjustment and each subsequent yearly adjustment with a lifetime increase of no more than 5%. Most ARMs have 30-year terms.
In contrast, fixed rates are often slightly higher than the teaser rates on ARMs, but they remain fixed for the loan’s life. For this reason, it can be a benefit to refinance from an ARM into a fixed-rate mortgage even if the rate is slightly higher because of the certainty.
Reduced Monthly Payment
Another potential benefit is a lower monthly payment. This is great because it puts money back in your pocket every month that can be used for other things, whether that’s saving for retirement, a vacation or college fund, maintenance or another purpose.
Reduced Loan Interest Rate
If you have a lower interest rate, you’ll save money over time by paying less interest over the life of the loan. No one wants to give a lender more interest than they have to. Getting into a lower rate will always be beneficial if you can afford the monthly payment.
Reduced Loan Term
If you lower the number of years on your term, that’s a benefit even if the interest rate stays the same because you’re going to pay off more principal faster to meet the shorter payoff time frame. Putting more toward principal means less toward interest.
There’s also the added benefit that shorter terms also tend to come with lower interest rates. The reason for this is that investors don’t have to project inflation as far in advance with shorter terms.
Another potential benefit is the ability to convert your existing home equity into cash. This gives you the opportunity to do home improvements, pay for expenses like medical bills or save for a retirement or college fund. You could even start a business.
You can use a cash-out refinance to pay off debts that have a higher interest rate than you’d get on your mortgage. The key to whether this is beneficial comes down to a simple calculation.
The refinance is considered beneficial for debt consolidation purposes if, after calculating your new payment when taking equity out, your mortgage payment is lower than the combined payments of any debts being paid off in the transaction. If this is the case, you have more residual income after the refinance and it’s considered beneficial.
Tangible Net Benefits And FHA Streamline Refinances
An FHA Streamline refinance allows those who have an existing FHA loan to do a rate/term refinance into another FHA loan for the purposes of a lower interest rate, modified mortgage term and/or a lower mortgage insurance rate.
FHA Streamline refinances come with lower mortgage insurance rates. When you do an FHA streamline, your existing FHA loan is paid off and you move forward under a new mortgage with a different term.
To have the term reduced on an FHA Streamline, three things have to occur:
- The term needs to be shorter than the previous one.
- The combined principal, interest and mortgage insurance premium (MIP) can’t be more than $50 higher than the previous payment.
- If going from a fixed loan to another fixed loan, you need the prior combined rate (interest plus MIP rate) be lower than your previous rate. If you’re going from an ARM to a fixed loan, the combined rate can be no more than 2% higher.
If your term isn’t being reduced, a different set of factors comes into play depending on the circumstances of the transaction:
- Fixed to fixed: Your combined rate on the new loan must be at least 0.5% below the combined rate on your current loan.
- ARM to fixed: The new rate can’t be more than 2% higher than your previous combined rate.
- Fixed to ARM: The new combined rate must be at least 2% lower than your previous combined rate.
- ARM to ARM: The new combined rate needs to be at least 1% lower than your current combined rate.
FHA Net Tangible Benefit Forms
When deciding on the net tangible benefit, the Department of Housing and Urban Development (HUD) has a worksheet that lenders have to fill out to determine whether someone is eligible for a streamline.
In addition to basic client and property information, some of the questions that must be answered include the loan type, the combined interest rate and payment information for the client in order to determine whether a benefit really exists.
At closing, a client is required to knowledge that they understand the benefit they’re getting by doing the refinance. It’s a way of confirming that this is worth it before taking the final act of signing on the dotted line.
Tangible Net Benefits And VA Loans
VA loans have a tangible net benefit calculation that applies to many of their transactions. For the VA policy not to apply, a homeowner must have 10% equity or more.
In all other rate/term (excluding VA streamlines, which we’ll get into below) and cash-out transactions, one of the following must happen to pass the test:
- Going from an ARM to a fixed-rate mortgage
- Refinancing from a construction loan into a traditional mortgage
- The new interest rate is lower than the one on the existing loan
- The term after refinancing is shorter than the previous term
- The client is refinancing to eliminate monthly mortgage insurance premiums
- The new loan has a lower principal and interest payment than the previous monthly principal and interest payment
- In a debt consolidation, the higher monthly mortgage payment is less than the monthly payment on the debt the client is consolidating. They have to end up with a higher residual income level to qualify under this test.
Tangible Net Benefits And VA Streamline Refinances
VA Streamlines (also referred to as the Interest Rate Reduction Refinance Loans, or IRRRLs) are refinances of existing VA loans to help lower the interest rate or change your term. As with an FHA Streamline, in a VA Streamline, you’re paying off your existing VA loan and taking on a new one under different terms.
For a VA Streamline to have a net tangible benefit, three conditions must be met.
The first thing to worry about is the timeline. The VA wants to make sure that lenders aren’t constantly trying to get you to close a new loan to collect another fee.
Because of this, 212 days have to pass between the time of your first payment due date on your original loan and closing on your new one. You also must have 6 months of consecutive payments made.
Any fees associated with the loan must be able to be paid back within 3 years of the closing date to pass the benefits test.
Finally, there’s a rate test that’s very similar to an FHA Streamline.
- Fixed to fixed: There needs to be interest rate reduction of at least 0.5%.
- Fixed to ARM: The interest rate reduction must be at least 2%.
To the extent that the interest rate reduction is achieved by buying mortgage discount points, if you buy more than one point (1% on the loan amount), you have to have at least 10% equity, verified by an appraisal.
VA Net Tangible Benefit Forms
Just like with an FHA Streamline, a lender has to show their work to both the client and the VA to provide the benefit by doing the math. The net tangible benefit form is signed at closing by the client acknowledging that they received the form and understand the advantage of the refinance.
Tangible Net Benefits And Other Types Of Refinances
It’s not only the government that has strict requirements around showing a net tangible benefit for the loans they back. States and even lenders may have their own tangible net benefit requirements.
The specifics of the rule will vary based on the state and the lender, but they’re going to revolve around one of several factors:
- Saving money on a payment: This can be based on a lower monthly mortgage payment or savings gained through debt consolidation.
- Shorter term: Going to a shorter term can save you money on interest even at an equal rate.
- Lower rate: A lower rate also means less interest paid.
- Elimination of mortgage insurance payments: Eliminating mortgage insurance payments can mean significant monthly savings.
- Taking cash out: Taking cash out allows you to use the existing equity in your home for other purposes, like building a college fund, saving for retirement or home maintenance.
The Bottom Line
When you refinance, there’s often a requirement that you receive some sort of net tangible benefit because of the transaction. This can take the form of payment savings, the ability to convert existing equity into cash, lower interest rates or shorter terms.
Lenders may have tangible net benefit regulations, and they may also be set at the state level. The FHA and VA have net tangible benefit regulations built into some of their loan programs as well. A client is often required to certify that they understand the advantage of refinancing, and lenders must complete a breakdown.
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