Table of Contents
- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
What is a Net Tangible Benefit?
When you choose to refinance your home there are a few reasons, like lowering the rate and/or changing the term of the loan, taking cash out for investment or revamping the house, or for debt consolidation.
While home financing you want to make sure you’re getting the best deal when you apply to refinance.
The lenders usually make sure that the refinancing accomplishes one or more tangible net benefits for the borrower which safeguards them against predatory lending practices.
Knowing Net Tangible Benefit
A net tangible benefit can be termed as the advantage that a client benefits by refinancing.
You’re taking on a completely new loan when you refinance your mortgage loan so many states and the federal government require that there should be a defined benefit for you in many cases.
If you’re a resident of states that has these types of homeowner protection laws on the books, or if your loan is backed by a certain federal agency like the Department of Veterans Affairs or Federal Housing Administration, then there has to be a tangible net benefit In one form or another when you undertake any refinance.
If you’re not in one of the covered states and a federal agency is not covering your loan than that is the only time you might not have a tangible net benefit.
Which is a rarity because it’s very difficult to maintain a policy that’s not uniform if the lender does business in any covered state or sells any federally backed loans.
And also any well-intended business will put the client first, so they can engender goodwill and get repeat business down the line.
What is Considered as a Net Tangible Benefit?
Now let us know what constitutes a benefit for the client, there are several ways a loan can pass the test.
Depending on your state or the federal agency The applicable regulation could come from the state you reside in or a federal agency after mentioning the type of loan you’re getting.
In many cases, well-established lenders have their own standards.
1 – Converting an ARM to a Fixed-rate mortgage
When you are moving from an adjustable-rate mortgage to a fixed-rate mortgage that is the first instance where refinancing would have a net tangible benefit.
So you 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.
Normally the ARM’s loan employs a concept called the teaser rate for a period of 5, 7, or 10 years.
At the beginning of the loan term, you usually get a rate that is slightly lower than you could get on a fixed-rate mortgage for the same 30-year term.
Once the teaser period is up based on an index added to a margin the rate can adjust to the current market conditions by going up or down, which is why investors can offer a lower interest rate.
When an ARM goes up, it can’t go up indefinitely because there are caps built into the contract. There are initial adjustment caps and caps for each subsequent adjustment and lastly a lifetime cap.
Let us take the example of: 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 and then adjustments once per year after that is represented by 1.
The part after ARM is the caps. In this example, 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 ARM’s have 30-year terms.
While often, fixed rates are slightly higher than the teaser rates on ARM’s, but they remain fixed for the life of the loan.
This is the 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.
(Now of course due to the low-rate environment during COVID-19 the fixed rates are lower than the adjustable-rate mortgages)
2 – To Reduce Monthly Payment
A lower monthly payment is another potential benefit.
It is beneficial because every month it puts money back in your pocket, so that can be used for other things, like saving for retirement, or for a vacation, or college fund, maintenance, or other multiple purposes.
3 – Reduced Loan Interest Rate
You’ll be saving money over time by paying less interest over the life of the loan when you have a lower interest rate.
If you can afford the monthly payment then letting into a lower rate will always be beneficial.
4 – Reduced Loan Term
Even if the interest rate stays the same but if you can lower the number of years on your term, that’s beneficial because you’re going to pay off a larger chunk of principal faster to meet the shorter payoff time frame.
When you put more toward principal it means less toward interest.
The added benefit is that shorter terms tend to come with lower interest rates. Because the investors don’t have to project inflation as far in advance with shorter terms.
5 – Cash-Out Benefits
The ability to convert your existing home equity into cash is another potential benefit.
This gives you the opportunity to do improvements or pay off the expenses of medical bills or save for a retirement or college fund. Or you could even start a business.
6 – Debt Consolidation
A cash-out refinance can be used to pay off debts that have a higher interest rate than you’d get on your mortgage. When you do a simple calculation it shows whether this is beneficial to you or not.
When taking equity out after calculating your new payment, if your mortgage payment is lower than the combined payments of any debts being paid off in the transaction then the refinancing is considered beneficial for debt consolidation purposes.
Then you have more residual income after the refinancing, and it’s considered beneficial.
Net Tangible Benefits / FHA Streamline Refinances
For the purposes of a lower interest rate, modified mortgage term, and/or a lower mortgage insurance rate, an FHA streamline refinance allows those who have an existing FHA loan to do a rate/term refinance into another FHA loan.
The FHA Streamline refinance come with lower mortgage insurance rates.
Your existing FHA loan is paid off, and you move forward under a new mortgage with a different term When you do an FHA streamline.
Three things have to occur to have your term reduced on an FHA Streamline:
- The term has to be shorter than the previous one.
- The combination of principal, interest, and mortgage insurance premium (MIP) should not be more than $50 higher than the previous payment.
- The prior combined rate (interest plus MIP rate) when going from one fixed loan to another fixed loan, should be lower than your previous rate. And the combined rate cannot be higher than 2% if you’re going from an ARM to a fixed loan.
If your term isn’t being reduced, then depending on the circumstances of the transaction a different set of factors comes into play:
- Fixed to fixed: The combined rate on your new loan should be at least 0.5% below the combined rate on your current loan.
- ARM to fixed: The new rate should be less than 2% higher than your previous combined rate.
- Fixed to ARM: Compared to your previous combined rate the new combined rate must be at least 2% lower.
- ARM to ARM: The new combined rate must be at least 1% lower than your present combined rate.
FHA Net Tangible Benefit Forms
To determine whether someone is eligible for a streamline the Department of Housing and Urban Development (HUD) when deciding on the net tangible benefit has a worksheet that lenders have to fill out.
In order to determine whether a benefit really exists – along with the basic client and property information, the questions that must be answered are the loan type, the combined interest rate, and payment information for the client.
A client is required to acknowledge at the time of closing, that they understand the benefit they’re getting by doing the refinancing.
So before taking the final act of signing on the dotted line this is a way of confirming that it is worth it.
Net Tangible Benefits / VA Loans
There is a tangible net benefit calculation that VA loans have which applies to many of their transactions.
A homeowner must have 10% equity or more for the VA policy not to apply.
Excluding VA streamlines in all other rates/term and cash-out transactions, to pass the test, one of the following must happen:
- Moving from an ARM to a fixed-rate mortgage
- Refinancing to a traditional mortgage from a construction loan
- The new interest rate is not higher than the one on the existing loan
- The term after refinancing must be shorter than the previous term
- The client is refinancing to get rid of monthly mortgage insurance premiums
- The previous monthly principal and interest payment is higher than the new loan principal and interest payment
- In debt consolidation, the higher monthly mortgage payment is not more than the monthly payment on the debt the client is consolidating. To qualify under this test they have to end up with a higher residual income level.
Net Tangible Benefits and VA Streamline Refinances
The Interest Rate Reduction Refinance Loans, or IRRRLs or VA streamlines are refinancing of existing VA loans to help lower the interest rate or change your term.
As with an FHA Streamline, in a VA Streamline, the borrower would be paying off their existing VA loan and taking on a new one under different terms.
Three conditions must be met for a VA Streamline to have a net tangible benefit.
The first is the timeline. Where the VA wants to make sure that you are not being pushed by the lenders to get you to close a new loan to collect another fee.
That is why 212 days have to pass between the time of your first payment due date on your original loan and closing on your new one. And also you must have 6 months of consecutive payments made.
To pass the benefits test any fees associated with the loan must be able to be paid back within 3 years of the closing date.
Finally, very similar to an FHA Streamline there’s a rate test.
- Fixed to fixed: An interest rate reduction of at least 0.5% should be there.
- Fixed to ARM: Here the interest rate reduction must be at least 2%.
Net Tangible Benefits and Refinances
States and even lenders may have their own tangible net benefit requirements like the government, which has strict requirements around showing a net tangible benefit for the loans they back.
Based on the state and the lender the specifics of the rule will vary, but they’re going to revolve around one of several factors:
- Saving money on a payment: By a lower monthly mortgage payment or savings gained through debt consolidation.
- Shorter term: When you go for a shorter term you can save money on interest even at an equal rate.
- Lower rate: A lower rate would mean less interest to be paid.
- Elimination of mortgage insurance payments: Eliminating mortgage insurance payments will result in significant monthly savings.
Taking cash out: When you take cash out it allows you to use the existing equity in your home for other purposes, like building a college fund, saving for retirement, or home maintenance.
Net Tangible Benefit Forms
A lender has to show his work to the client and the VA to provide the benefit by doing the math just like with an FHA Streamline.
At closing the client signs the net tangible benefit form acknowledging that they received the form and understand the advantage of the refinancing.
Conclusion
When you refinance, you receive some net tangible benefit because of the transaction.
Like payment savings, or the ability to convert existing equity into cash, lower interest rates, or even shorter terms.
States and lenders, the FHA and VA have net tangible benefit regulations in some of their loan programs. A client is needed to certify that they understand the advantage of refinancing.
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