Last year, when President Trump signed the Economic Growth, Regulatory, and Consumer Protection Act into law, all types of VA refinance loans experienced some significant changes.
In mid-December, the VA released a circular outlining the new rules specifically for cash-out refinance loans. These rules define how lenders should put the law into practice so they are in compliance. To put it another way, the rules are a practical application of the larger law.
When the New Rules Go into Effect
According to the circular, the new rules for VA cash-out loans go into effect on February 15, 2019. They apply to all VA cash-out refinance loans that are written on that date or after.
3 Main Changes to VA Cash-Out Rules
On February 15th, there are three main changes that will go into effect:
- An update to the requirements for the loan-to-value (LTV) percentage
- The addition of a net tangible benefits (NTB) test
- A requirement for new disclosures to be given to the borrower
In the sections below, we’ll cover each of these changes, including the history of what they used to be and how they will be changing on February 15th.
1. Changes to the LTV Percentage
The total loan amount for a VA cash-out refinance loan can no longer exceed 100% of the home’s value.
How the LTV Percentage Used to Work for Cash-Out Loans
Historically, one of the benefits of a VA cash-out refinance loan was the ability to refinance up to 100% of your home’s value. Many other cash-out refinance types, including conventional and FHA cash-out refinances, limit borrowers to only taking out up to 80%, or sometimes 90%, of their equity.
However, because VA cash-out loans allow you to roll the funding fee into your loan amount, rather than paying it up front at closing, borrowers who refinanced 100% of their home’s value would end up with a loan amount that was greater than the value of their home.
Here’s an example of how it used to work:
She decides to refinance the full value of her home—all $300,000 of it. Because she’s rolling in her closing costs (which we’ll say end up being $12,000, or 4%, for this example), she’ll get $88,000 in cash back. This will almost cover her son’s first year of tuition.
On top of her loan and the other closing costs, Shaundra also decides to finance the VA-required funding fee into the loan amount. Since she has used her VA eligibility before, for her current home loan, she is charged a 3.3% funding fee, which comes out to $9,900.
By financing the funding fee into her loan, it brings the total amount of Shaundra’s new home loan to $309,900.
As you can see, Shaundra’s new loan ($309,900) is for more than her home is worth ($300,000). While this used to be allowed under the VA’s rules for the loan-to-value ratio of cash-out refinances, their new rules prohibit it.
How the LTV Requirement Has Changed
So what is allowed? The new rule states that the borrower’s total loan amount (including any financed closing costs or funding fee) cannot exceed 100% of the home’s value.
Let’s put that in real terms. The rule is basically saying that if the borrower wants to finance their closing costs and funding fee into the loan amount, it reduces the how much they’re able to get in cash back.
Going back to Shaundra’s example, if she wants to finance her 4% closing costs and 3.3% funding fee into the loan, she can no longer get the full $88,000 in cash out. Instead, the most she could get would be just over $79,500. Here’s how the math works:
We can then calculate the LTV percentage by dividing her total loan amount ($299,903.50) by the appraised value of her home ($300,000). This gives us 0.999. Multiplied by 100 to get the percentage, Shaundra’s loan is now at 99.9% of the value of her home, making her loan in compliance with the new rules.
2. Passing the Net Tangible Benefits (NTB) Test
What counts as a “net tangible benefit” is limited to eight defined options; all VA cash-out refinance loans must meet at least one of them to pass.
How Net Tangible Benefits Worked Before
Cash-out loans have always had a net tangible benefit requirement. However, they haven’t always had to pass a net tangible benefit test.
Basically, prior to this rule change, what constituted a net tangible benefit was up to the lender. As long as they could persuade the VA that there was some kind of benefit to the borrower, they could write the loan.
Some unscrupulous lenders would use this to their advantage by saying there was a benefit, but when put into practice in real life, the “benefit” to the borrower was almost negligible. It might even be harmful, if the long-term cost of the refinance put them into a worse financial situation.
The goal of both the Economic Growth, Regulatory, and Consumer Protection Act and the VA’s rules interpreting it is to prevent this kind of situation from ever being able to happen at all.
How Net Tangible Benefits Work Now
The new rules define eight specific situations that count as a net tangible benefit. Together, these eight conditions are called the net tangible benefit test.
What counts as a net tangible benefit is no longer up to the lender, or their persuasive powers. Either the cash-out refinance meets one of the eight conditions, or it doesn’t.
If it doesn’t, then the lender can’t do the loan. But if it does, then the loan passes the test.
So what are these eight conditions? We’re glad you asked:
- Mortgage insurance (PMI, MIP, etc.) is eliminated
- The loan has a shorter term
- The interest rate decreases
- Monthly mortgage payments are lower
- The borrower’s monthly residual income increases
- The refinance is replacing a construction (or other interim) loan
- The total loan amount is below 90% of the home’s appraised value
- The loan moves from an adjustable to a fixed rate
Again, in order to pass, the cash-out refinance doesn’t have to pass all eight conditions. It only needs to pass one.
3. New Disclosures for the Borrower
Lenders must now disclose additional information about the refinance to borrowers, including what is changing and how it affects them.
Disclosures Before the Rule Change
VA cash-out refinance loans have always had disclosures. This rule change is simply adding to them by outlining new information that must be included.
How Disclosures Are Changing
The VA’s circular lists two specific sets of information that lenders must now give to their borrowers at two specific times during the loan process:
- Within 3 business days of receiving the loan application
- At closing
The first new disclosure compares key characteristics of the original loan against the refinanced loan. These characteristics are:
- The refinanced loan amount vs. the payoff amount of the original loan
- The loan type (adjustable, fixed, etc.) for both loans
- The interest rate for both loans
- The loan term (15 years, 30 years, etc.) for both loans
- The total long-term costs for both loans (principal and interest, plus any mortgage insurance)
- The LTV for both loans
The second new disclosure should provide an estimate of how much equity the veteran is losing. It must also explain how the loss of this equity may affect them.
What These Changes Mean for Veteran Borrowers
For starters, because lenders are facing more limitations on when and how they can do VA cash-out refinance loans, you may find it a little more difficult to get one.
You will also be more limited on how much money you can get back from the loan, which could affect what you were planning on using it for.
However, these disadvantages are offset by the fact that cash-out loans, when you do get one, will ultimately be a little safer for you. The goal is to make them less risky, especially when it comes to your financial health.
For example, because you can no longer get 100% cash back on your home’s equity, you will never be underwater on your loan due to a refinance (though it could still happen from other external causes).
Thanks to the NTB test, the benefits of a refinance really should outweigh the costs associated with it, putting you in a better overall situation.
And finally, the new disclosures will help make sure you have all the information you need to decide for yourself if a refinance is truly in your best interest.
Have Any Questions?
If you still don’t feel like you understand these changes, feel free to give us a call at (866) 569-8272. When you call us, there is never any obligation or expectation that you have to get a loan with us. We’re simply here to help you, and the honor of writing your loan is just the icing on the cake.
That’s because at Low VA Rates, we believe our veterans should understand the loan process. By arming you with knowledge, we equip you with the tools you need to make the right decision about your home. We like to think that our full transparency makes us unique in the loan world.