By: Timothy A. Raty; Sr. Regulatory Compliance Specialist
An overlooked aspect of the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”; 132 Stat. 1296 [2018]), Section 309 (aka “The Protecting Veterans from Predatory Lending Act”), is that Congress may have (inadvertently) severely restricted the types of fixed-rate VA Interest-Rate Reduction Refinance Loans (“IRRRLs”) and so-called “Type I Cash-Out Refinance Loans” (see 83 FR 64459 [2018] and VA Circ. 26-18-30 & 26-19-5) which refinance a previous adjustable-rate mortgage.
Subsection 309(b) (codified as 38 U.S.C.A. § 3709[b]) states the following for IRRRLs and Type I Cash-Outs (cited in relevant part; emphasis added):
“Except as provided in subsection (d) [which exempts so-called ‘Type II Cash-Out Refinance Loans’] and notwithstanding section 3703 of this title [which contains basic provisions relating to loan guaranty and insurance] or any other provision of law, a loan to a veteran for a purpose specified in section 3710 of this title [which outlines which loans qualify for a VA guaranty] that is refinanced may not be guaranteed or insured under this chapter unless –
(1) the issuer of the refinanced loan provides the borrower with a net tangible benefit test;
(2) in a case in which the original loan had a fixed rate mortgage interest rate and the refinanced loan will have a fixed rate mortgage interest rate, the refinanced loan has a mortgage interest rate that is not less than 50 basis points less than the previous loan;
(3) in a case in which the original loan had a fixed rate mortgage interest rate and the refinanced loan will have an adjustable rate mortgage interest rate, the refinanced loan has a mortgage interest rate that is not less than 200 basis points less than the previous loan; and
(4) the lower interest rate is not produced solely from discount points, unless [certain conditions are met].”
A strict interpretation of this subsection (and one originally supported by VA Circ. 26-18-13) is that the “net tangible benefit test” (“NTB test”) referred to in Subsection (b)(1) consists of the three criteria set forth in Subsections (b)(2) through (b)(4). Thus, an IRRRL or a Type I Cash-Out must meet one of the following three criteria:
- Be a fixed-rate to fixed-rate (“FRM-to-FRM”) refinance with a lower interest rate meeting a certain basis point threshold;
- Be a fixed-rate to adjustable-rate (“FRM-to-ARM”) refinance with a lower interest rate meeting a certain basis point threshold; or
- Have a lower interest rate not solely produced from discount points, unless certain conditions are met.
No criterion is specifically given for adjustable-rate to fixed-rate (“ARM-to-FRM”) IRRRLs and Type I Cash-Outs. This would seemingly make only the third criterion, mandating that the interest rate of such loans must be less than the loan being refinanced, applicable. Essentially, this means that ARM-to-FRM IRRRLs and Type I Cash-Outs with an interest rate which is the same or temporarily higher than the current rate on the ARM being refinanced are no longer guaranteed by the VA.
Further compounding this matter is that Subsection 309(a)(3) of the EGRRCPA stipulates that, for IRRRLs and Type I Cash-Outs, a lender must demonstrate that the borrower is able to recoup the costs of such refinances within 36 months of loan issuance and that such “recoupment is calculated through lower regular monthly payments (other than taxes, amounts held in escrow, and fees paid under this chapter [37]) as a result of the refinanced loan.” It is difficult to see how this requirement can be met if the interest rate is the same or higher than the loan being refinanced (short of a restructuring of the loan term or principal balance).
Despite their original conclusions in VA Circ. 26-18-13, the VA has changed their interpretation of 38 U.S.C.A. § 3709(b) and how it applies to Type I Cash-Outs. A detailed analysis can be found in 83 FR 64459 – 64462 (2018), but notably, the VA holds that the third criterion referenced above only forms a part of the second criterion, rather than being its own criterion. This means that – using the VA’s original definition of the NTB test – there is only two criteria:
- The loan must be an FRM-to-FRM refinance with a lower interest rate meeting a certain basis points threshold; or
- It must be an FRM-to-ARM refinance with a lower interest rate meeting a certain basis points threshold and that such a lowering of the interest rate cannot occur solely due to discount points (unless certain conditions are met).
A severe conclusion stemming from such a re-interpretation is that Type I Cash-Outs must meet one of these criteria. Constructively, this would prohibit any ARM-to-FRM Type I Cash-Outs from being guaranteed by the VA. If the same interpretation applies to IRRRLs, then ARM-to-FRM IRRRLs would also be prohibited (despite VA Lender’s Handbook ch. 6, 1-b & 1-c).
However, the VA also re-interpreted 38 U.S.C.A. § 3709(b)(1) to hold that the NTB test is separate from the two criteria referenced above. Essentially, to be acceptable to the VA, a Type I Cash-Out must meet one of the following criteria:
- The loan must pass an NTB test (which test is defined by the VA);
- It must be an FRM-to-FRM refinance with a lower interest rate meeting a certain basis points threshold; or
- It must be an FRM-to-ARM refinance with a lower interest rate meeting a certain basis points threshold and that such a lowering of the interest rate cannot occur solely due to discount points (unless certain conditions are met).
The VA rationalized this re-interpretation, in part, as follows:
“VA also considered whether the net tangible benefit test described in (b)(1) was introductory to the criteria set forth in (b)(2) through (4). In other words, VA analyzed whether the required interest rate reductions, restricted discount points, and capped loan-to-value ceilings of paragraphs (2) through (4) comprise, in total, the net tangible benefit test mentioned in paragraph (1). This reading also was untenable, however, due to the way Congress structured the plain text of subsection (b). Subsection (b) contains four paragraphs, not three. Had Congress intended for paragraphs (2) through (4) to comprise the net tangible benefit test, Congress would have made the net tangible benefit test part of the introductory text as an overarching requirement, leading into the list of various elements necessary for passing the test. Yet the equal paragraph structure of the loan clearly sets the net tangible benefit test as one criterion of equal weight among other necessary to be met for guaranty or insurance. . . .
In this rule, VA is defining the parameters of the net tangible benefit test for Type I Cash-Outs. VA is also establishing a net tangible benefit test for Type II Cash-Outs to comply with section 3709(d). The net tangible benefit test for both types of cash-outs overlaps in some ways, but also differs in a few major respects. . . .” (83 FR 64460 & 64462 [2018])
By so doing, the VA provided a “loophole” of sorts which permits an ARM-to-FRM Type I Cash-Out to be guaranteed by the VA – including those where the interest rate increases (see 38 C.F.R. § 36.4306[a][3][i] for the NTB test criteria).
What of ARM-to-FRM IRRRLs, especially those where the interest rate is the same or increases from the current rate? As of today, no guidance is provided. A strict interpretation of the statutory requirements would hold that these types of loans may be guaranteed by the VA, but only if the interest rate decreases.
If the VA’s rationale in their interim final rule promulgated in 83 FR 64459 (2018) is applied to IRRRLs, an ARM-to-FRM IRRRL can only be guaranteed if it passes the NTB test – which test has not been defined for IRRRLs (the final rule only applies to Types I and II Cash-Outs).
Thus, failing to meet an undefined test, the loan would be subject to the remaining two criteria set forth in the final rule, both of which only apply to FRM-to-FRM and FRM-to-ARM refinances. As a result, ARM-to-FRM IRRRLs are prohibited (regardless of whether the interest rate increases, decreases, or remains the same).
The VA has stated that they are planning on addressing how the provisions of 38 U.S.C.A. § 3709 apply to IRRRLs in a future rulemaking (see 83 FR 64460 & 64462 [2018]). Hopefully such rulemaking clarifies whether and how ARM-to-FRM IRRRLs can be guaranteed by the VA. Until such time, however, lenders are left with very little guidance and an abundance of questions on this matter.