BLOG VIEW: The net tangible benefit test asks a tough question: Should borrowers be allowed to refinance even when it’s not in their best interest? This sounds like a pretty obvious matter – no, the borrower should not refinance without some benefit – but then who is to say what’s best for the borrower?
When a mortgage is refinanced, both the borrower and the lender should come out ahead, a win-win. But for a few lenders a win-win situation is not the goal. Instead they engage in so-called “churning” or “serial refinancing.” The results are bad for borrowers and costly for investors.
For years, churning was an evasion of standards and not quite a violation of the rules. But with net tangible benefit requirements spouting up that’s no longer the case. Churners beware, the practice is now at an end.
Churning and the Net Tangible Benefit
With churning the idea is to originate multiple loans to one borrower over a short time that produce little if any real benefit for the homeowner – but big fees for the lender. If rates quickly fall by three-eighths of a percent, Lender Jones might propose that Smith refinance his property to catch a one-eighth-percent rate reduction. Six weeks later, Jones calls again saying another one-eighth savings is now available. Two months later, Jones calls once more….
At first this might seem like an unlikely series of events, but research shows otherwise. In Massachusetts, as one example, more than 400 Veterans Affairs loans were refinanced within six months of origination between April 2016 and November 2017.
Part of the problem is that past net tangible benefit standards weren’t clear. As Fannie Mae pass-through certificates note, “under certain state laws enacted to combat predatory lending, lenders are required to ensure that the loan confers a net tangible benefit to the borrower or that the transaction is in the ‘borrower’s interest.’ This test may be highly subjective and open to interpretation.”
“Moving toward more specific net benefit standards is good for all parties involved in refinancing a mortgage,” explains Rick Sharga, executive vice president of Carrington Mortgage Holdings. “Borrowers are protected from needless loan churning, originators have clear guidelines to follow, and investors are protected from an excess number of early prepayments.”
In January Sen. Thom Tillis (R-NC) and Sen. Elizabeth Warren (D-MA) introduced S. 2304, the Protecting Veterans from Predatory Lending Act of 2018. The Tillis-Warren proposal – with a lot of bipartisan backing – ultimately became part of the Economic Growth, Regulatory Relief, and Consumer Protection Act, legislation introduced by Sen. Mike Crapo (R-ID) and passed in May. The May legislation takes direct aim at serial lending – but only for VA borrowers.
According to the Mortgage Bankers Association, the Crapo measure establishes three new requirements for VA rate-and-term refinancing.
- Fee recoupment within 36 months;
- Net tangible benefits to the borrower, measured as a decrease of at least 50 basis points in the interest rate in the case of a fixed-to-fixed refinance, and at least 200 basis points in the interest rate in the case of a fixed-to-floating refinance; and
- Seasoning of the initial loan for at least 210 days, calculated from the date of the first payment made by the borrower to the note date of the refinanced loan (at least six monthly payments must also have been made by the borrower).
In addition to the newly-minted VA requirements, net tangible benefit standards can also be found with other lending programs.
HUD says that a net tangible benefit for Federal Housing Administration borrowers can include “a reduced combined rate, a reduced term and/or a change from an ARM to a fixed-rate Mortgage that results in a financial benefit to the Borrower.” The FHA Single Family Housing Policy Handbook also includes a matrix for streamline refinances:
Freddie Mac explains that it requires “all documents necessary to evidence compliance with all applicable anti-predatory lending laws and regulations including, for example, any required reasonable tangible net benefit analysis, Borrower disclosures or disclosures relating to affiliated business or service providers.”
Fannie Mae has a somewhat different approach. It uses the term “benefit provision” in its Selling Guide to say that borrowers must receive at least one or more basic advantages from refinancing. The benefit categories include:
- A reduced monthly mortgage principal and interest payment;
- A more stable mortgage product;
- A reduction in the interest rate; or
- A reduction in the amortization term.
For most lenders, the new net tangible benefit tests will not impact originations – but for churners the story is different. The new standards will effectively prevent serial refinancing, something good for borrowers and mortgage investors, and something long overdue.
Peter G. Miller is a nationally-syndicated real estate columnist. His books, published originally by Harper & Row, have sold more than 300,000 copies. He contributes to such leading sites as AttomData.com, TheMortgageReports.com and CarringtonHC.com. Miller has also spoken before such groups as the National Association of Realtors and the Association of Real Estate License Law Officials.