Question: I’m a vet and recently heard that a VA mortgage has become more difficult to refinance for borrowers like me. What are the new rules and why is the VA making things harder for veterans?
Answer: The VA is on your side. They haven’t made it “harder” for vets to refinance, what they’ve done is to protect vets from predatory lenders. You want to support the VA in this matter.
The VA mortgage program is one of the benefits available to individuals with qualifying federal service, typically active-duty members of the military and vets no longer the military. With VA financing a qualified borrower can finance the purchase of a home with zero down.
No less important, the VA has a very liberal debt-to-income (DTI) standard. It says that as much as 44 percent of your gross monthly income can go to recurring costs such as housing expenses, student loans car payments, and credit card debt.
Most loan programs say you can have a DTI of 43 percent but that monthly housing costs cannot exceed 31 percent of your gross monthly income. The VA does it differently. It says housing costs by themselves can represent as much as 44 percent of your gross monthly income. What this really means is that if you’re a VA borrower and have stayed away from debt you can get a surprisingly large mortgage with nothing down.
The VA not only looks at a borrower’s DTI it also looks at residual income. In other words, how much cash is available to the borrower for general living expenses? The VA requires that borrowers have a given amount of cash available to them each month, depending on family size and where the property is located.
VA mortgage refinancing
VA qualified borrowers can get financing to buy or refinance real estate. Recently, however, a problem has emerged with VA refinancing. The vet is talked into refinancing with little benefit while lenders collect big fees and charges.
In May the government passed the Economic Growth, Regulatory Relief, and Consumer Protection Act. One section of the new law relates to “protecting veterans from predatory lending” and this is the reason that VA refinancing standards have been changed.
Okay, so what do the new rules require? To prevent churning the legislation creates three requirements.
The fee recoupment test
Only the government could come up with a term such as “fee recoupment.” In plain language the new law says that when a vet refinances the savings from the new loan must be sufficient to repay all fees, closing costs, and related expenses within 36 months. Such costs as money held in escrow and taxes do not count toward the cost calculation. Example: the Smiths are advised to get a new VA loan. If they refinance they can save $100 a month. The cost to refinance is $5,000. The refinance will not be accepted by the VA because the borrowers will not save at least $5,000 during the first three years of the new loan. If the cost to refinance had been $3,600 in this example the loan would meet the recoupment text.
Net Tangible Benefit Test
One of the key goals from refinancing should be a net tangible benefit. That’s a fancy expression meaning the borrower should get something good from the transaction. The new law requires a VA refinance to produce not just any net tangible benefit – say an extra $7 a month – but a benefit that meets a certain standard.
The new standard is that the cost of a fixed-rate mortgage must decline by at least a half a percent (50 basis points). For a refinancing where a fixed-rate loan will replace an ARM the requirement is that the interest rate must fall by at least 2 percent (200 basis points). There are also special rules which limit the use of discount points to reduce the interest rate.
The seasoning test
Predatory lenders often seek to refinance homes multiple times, a process called churning. Each time the loan is refinanced lenders collect big fees but the borrower sees little benefit. For instance, let’s say mortgage rates drop .50 percent. Instead of offering a new loan with a .50 percent rate cut, a predatory lender might offer to refinance the property to save the borrower .25 percent. A few months later the lender might offer to once again refinance the property for .25 percent. With each refinancing the lender collects thousands of dollars, money that the borrower could have saved.
Under the new rules the VA cannot approve a refinance unless it occurs 210 days after the last financing or six monthly payments have been made, whichever is later.
The three tests do not apply in the case of a cash-out refinancing, a situation where the borrower gets a loan for more than the original mortgage.
Are the new rules somehow harsh or unfair? Not hardly, they prevent vets from paying more than they should to refinance a home. That’s good for vets, good for the VA and good for honest lenders.