What Is A Tangible Net Benefit?

There are a few reasons a homeowner might choose to refinance their home. These include lowering their rate, changing the term of the loan (that is, the length of the loan), taking cash out for an investment/renovation, or using a cash-out refinance for 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. This serves as a safeguard against predatory lending practices. To that end, lenders must make sure the refinance accomplishes one or more tangible net benefits for the client.

Tangible Net Benefit, Defined

A tangible net benefit (alternatively referred to as a “net tangible benefit”) can be thought of as the financial advantage a client gains by refinancing. When you refinance your mortgage loan, you’re taking on a completely new loan. Many states and even the federal government require there to be a defined benefit for you in many cases.

If you’re a resident of states with these types of homeowner protection laws, there must be a tangible net benefit to any refinance you undertake. This restriction is also true if your loan is backed by certain federal agencies like the Department of Veterans Affairs (VA) or Federal Housing Administration (FHA).

Can You Refinance Without Net Tangible Benefits?

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. However, this is fairly unusual.

In practice, refinancing without a net tangible benefit is a rarity. This is because lenders do business across states. In any state that is covered or sells any federally backed loans, they’ll need to stick to the laws about net tangible benefits. This covers most situations which makes it very difficult for lenders to maintain a policy that’s not uniform.

Additionally, reputable lenders will put the client first. This not only creates a trusting relationship but also good will, referrals and hopefully repeat business.

What Counts As A Tangible Net Benefit?

Now that you know the reasons for tangible net benefit, what counts as 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 relevant regulation could be a state law or a rule from a federal agency. In many cases, lenders such as Rocket Mortgage^® have their own standards.

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 main upside here is that you secure your rate. Regardless of how the market fluctuates, your rate will remain the same or “fixed.” Understanding the mechanics of an ARM in comparison to a fixed-rate loan can help you learn why this change qualifies as a benefit.

ARM Benefits For Borrowers

The benefit of ARMs is that they employ a concept called the “initial” rate, which is fixed for a period at the beginning of the loan. This initial fixed rate is usually for the first 5, 7 or 10 years of the loan. With an ARM, you can usually get a slightly lower initial rate than current rates on a 30-year fixed-rate mortgage.

We say “usually” because there are rare instances where fixed rates may be lower than the adjustable ones.

ARM Benefits For Lenders

The reason investors can offer a lower interest rate is that once the initial period is up, the rate can adjust to be more in line with current market conditions. It can go up or down based on current interest rates.

If the rates on an ARM do go up, it can’t go up indefinitely. This is because caps are built into the contract to protect borrowers from extreme changes. There’s an initial adjustment cap and then a cap for each subsequent adjustment. Finally, there’s a lifetime cap.

Refinancing An ARM: An Example

If you decide to refinance to a fixed-rate loan, you’re trading the initial low rate for long-term stability. Fixed-rate mortgages are often slightly higher than the initial rates on ARMs, but they remain fixed for the loan’s life. After the introductory period, ARM rates might rise a maximum 5% from the initial rate (this is the lifetime cap).

For this reason, it can be a benefit to refinance from an ARM into a fixed-rate mortgage. Your interest rate may be slightly higher initially. However, the stability of the rate over time is a certainty and won’t be affected by unpredictable or a changing market. This stability is the main net tangible benefit for refinancing to a fixed-rate mortgage.

Additional Net Tangible Benefits

There are lots of reasons people decide to refinance and it isn’t always to switch the type of mortgage they have. Homeowners might be seeking some of these other net tangible benefits.

Reduced Monthly Payment

Another potential benefit of refinancing 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 you use the money to save for retirement, a vacation, 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 pay more interest than necessary. Getting into a lower rate is usually beneficial if you can afford the cost of refinancing.

Reduced Loan Term

If you lower the number of years on the length of the loan, that’s a benefit, even if the interest rate stays the same. That’s because you’ll pay off the principal of your loan faster to meet the shorter payoff time frame. Putting more toward principal means less toward interest over the life of the loan.

There’s the added benefit that shorter terms also tend to come with lower interest rates. This is because lenders, and the investors that buy mortgages, don’t have to project inflation as far in advance with shorter loan lengths.

Cash-Out Benefits

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 start a business among other possibilities.

Debt Consolidation

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.

Here is how you can tell if the refinance is considered beneficial for debt consolidation. After calculating your new payment when taking equity out, your mortgage payment should be lower than the combined payments of any debts you pay 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 Federal Housing Administration (FHA) loan to refinance into another FHA loan. Borrowers can do this to get a lower interest rate, modify their loan length or lower their mortgage insurance rate. Let’s take a look at some of the benefits you can access with an FHA streamline refinance.

Refinancing To Shorten Your Loan Length

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 loan length.

To have the length of the loan reduced on an FHA Streamline, three things have to occur:

• You need to commit to a loan length that’s at least 3 years 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.

Refinancing To Change Your Loan Type

If your loan length isn’t being reduced, a different set of factors comes into play depending on the circumstances of your refinance. Let’s take a look at some changes you could make to your loan type and the rules the FHA sets to ensure there is a net tangible benefit for the refinance.

• 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.

If you aren’t sure if you meet the qualifications for the loan change you’re considering, talk it over with us before you apply. We will help you determine if you qualify and help you find the right type of refinance for you.

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 will fill out to determine if you’re eligible for a Streamline refinance.

In addition to basic client and property information, your lender will specify the loan type, the combined interest rate and payment information for you. This process is used to determine if the net tangible benefits meet FHA qualifications.

At closing, a client is required to acknowledge that they understand the benefit they’re getting by refinancing. This is to confirm the benefit is worth it to you before you take the final step and sign on the dotted line.

Tangible Net Benefits And VA Loans

VA loans are backed by the Department of Veteran Affairs, and they have different rules for determining net tangible benefits. VA loans have a tangible net benefit calculation that applies to many of their transactions. For the VA’s policy not to apply, a homeowner must have 10% equity or more.

In all other rate-and-term (excluding VA Streamlines) and cash-out refinances, one of the following must happen to pass the VA’s test:

• You’re going from an ARM to a fixed-rate mortgage.
• You’re 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

A VA Streamline refinance (also referred to as the Interest Rate Reduction Refinance Loans, or IRRRLs) are refinances of existing Department of Veterans Affairs (VA) loans to help lower the interest rate or change your loan length. As with an FHA Streamline, in a VA Streamline, you’re paying off your existing VA loan and taking on a new one under a different set of rules.

For a VA Streamline to have a net tangible benefit, three conditions must be met.

Time Limits

The first thing to worry about is the timeline. The VA wants to make sure that lenders aren’t repeatedly asking you to close a new loan so they can collect another fee.

Because of this, 212 days must pass between the time of your first payment due date on your original loan and closing on your new one. You must also make 6 months of consecutive payments to meet the requirements.

Fee Limits

Next, 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.

Rates Limits

Finally, there’s a rate test that’s very similar to an FHA Streamline.

• Fixed to fixed: There needs to be an interest rate reduction of at least 0.5%.
• Fixed to ARM: The interest rate reduction must be at least 2%.

If you’re achieving an interest rate reduction by buying mortgage discount points it must meet the following rule. 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 verify the advantages of the refinance. A net tangible benefit form is signed at closing by the client acknowledging that they received the form and understand the advantage of the refinance. This is for both regular and IRRRL VA refinances.

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 interest rate.
• Lower rate: A lower rate also means less interest paid and is considered a benefit.
• 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 performing 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.

Now that you understand tangible net benefit, you can apply to refinance online. You can also feel free to give one of our Home Loan Experts a call at (833) 326-6018.