Achieving Net Tangible Benefit When Refinancing

The goal, when refinancing, is to get a new mortgage that’s better than the current mortgage. For most homeowners, “better” means paying less money each month for the same home. 

But beneath the surface, the costs and savings from a refinance happen on different schedules. This makes it harder to know whether, and when, a refinance will save money. 

Net tangible benefit — also called tangible net benefit — helps lenders and borrowers compare a loan’s savings to its costs. With some loan programs, an application can’t move forward unless it shows enough net tangible benefit for the borrower.

Why Do Lenders Require Proof of Net Tangible Benefit?

Requiring net tangible benefit ensures the refinance will save the borrower money or provide another financial benefit, said Andrew Latham, a Certified Financial PlannerⓇ and content director for the personal finance website SuperMoney.com.

“Net tangible benefit protects borrowers from wasting money in fees for a loan that doesn’t improve their financial situation,” he said. “Refinancing needs to clearly help the borrower, whether through lower payments, better terms, or reduced risk.”

Latham said net tangible benefit also protects lenders. When a new loan shows a net tangible benefit, borrowers are less likely to default. This helps protect the stability of lenders, mortgage investors, and mortgage insurers, which includes the federal government for FHA, VA, and USDA loans.

How Do Lenders Measure Net Tangible Benefit?

Lenders measure net tangible benefit by comparing the potential refinance to the homeowner’s current mortgage. They may also consider the homeowner’s overall financial health, especially when the homeowner plans to use a cash-out refinance to consolidate debt.

Government-insured mortgages, such as FHA and VA loans, tend to have stricter and more defined rules for net tangible benefit. This helps prevent homeowners from being taken advantage of through high-cost refinances that provide little to no benefit for the borrower. NTB requirements were adopted through regulations passed in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.

FHA Loans

An FHA Streamline Refinance eases the paperwork load for FHA borrowers who want to refinance into a new FHA loan. Many streamline borrowers can skip the credit check and the home appraisal, saving hundreds in upfront fees. 

Since these types of loans are easy to get, borrowers may pay for a new loan that doesn’t improve their long-term finances. Net tangible benefit rules provide a safety net for borrowers.

For FHA Streamline borrowers, net tangible benefit varies by loan scenario:

• Refinancing a fixed-rate loan into another fixed-rate loan: 0.5 percent total reduction in interest rate and/or mortgage insurance rate. For example, dropping mortgage insurance from 0.85 to 0.55 percent annually counts toward 0.3 percent of the required reduction.
• Refinancing to shorter loan term: New term must be at least three years shorter and add no more than $50 to the monthly payment
• Refinancing an adjustable-rate mortgage into a fixed-rate mortgage: New fixed rate no more than 2 percent higher than current ARM rate
• Refinancing an ARM into another ARM: New ARM rate must be 1 percent lower than the current rate; if ARM has more than 15 months until its rate adjusts for the first time, the new rate must be 2 percent lower than current ARM rate 

VA Loans

Private lenders originate VA loans, but they’re insured by the federal Department of Veterans Affairs as a benefit to active duty service members and veterans. Like the FHA, the VA seeks to protect borrowers through net tangible benefit rules. 

If one of the following is true, a VA refinance achieves net tangible benefit: 

• The refinance eliminates monthly mortgage insurance
• The new loan has a shorter term than the current loan
• The new loan lowers the current interest rate (the borrower can’t simply pay extra points to lower the rate to meet the rule)
• The monthly payment for principal and interest is lower than the current payment
• The new loan helps the borrower’s personal finances by creating more residual income
• The refinance loan pays off a temporary construction loan
• The new loan lowers the home’s loan-to-value (LTV) ratio to 90 percent or less
• The refinance replaces an adjustable-rate loan with a fixed one

VA-eligible borrowers who can get approved for a new VA refi usually meet several of these requirements. But per VA rules, loan underwriters must make sure borrowers benefit. The VA’s goal is to protect consumers from predatory practices and ensure borrowers have a payment they can afford.

What Numbers Equal Net Tangible Benefit for Conventional Loans?

Many conventional lenders use in-house worksheets which help them see loans side by side. Net tangible benefit can vary by lender, especially for conventional loans. 

For example, some loan programs require that the cost to refinance be recouped within 36 monthly payments. To meet this guideline, a borrower who pays $10,000 in closing costs would need to save $278 a month to earn back that $10,000 within three years. 

How much, and how soon, would your refi save? A refinance breakeven calculator can help you find out.

For non-government loans, there’s no universal formula for net tangible benefit. Instead, different loan programs and lenders define net tangible benefit based on their own criteria or by rules set by regulators.

“For example, they check if the borrower gets a significant reduction in their interest rate, often 0.5 percent or more,” Latham said. “Or they check if monthly payments drop noticeably after factoring in refinancing costs.”

Government-insured Streamline Refinances, like the FHA Streamline or the VA Interest Rate Reduction Refinance Loan (IRRRL) use their own specific recipes for net tangible benefit.

Scenarios Where Refinancing May Achieve a Net Tangible Benefit

A new refinance has several paths to net tangible benefit for the borrower. Some examples may include: 

Lowering Your Interest Rate

Interest paid to the lender can add hundreds of thousands of dollars onto the price of a home, especially when the loan stays open for a full 30-year term. Getting a loan with a lower interest rate reduces these finance charges, allowing the homeowner to pay less money for the same home. 

At first glance, any reduction in interest may look good to a homeowner. But there’s more to this net tangible benefit equation: The savings from the lower rate will play out slowly, in the form of lower monthly payments. The costs for a new loan, however, are due up front in the form of closing costs. 

Borrowers who cut only a fraction of a point from their interest rate — 0.125 percent, for example — will need many years to save back the money they paid in closing costs. Before they break even and start saving from the lower rate, the homeowner may have already sold the home or refinanced again.

That’s one reason, Latham said, that many lenders require a 0.5 percent or bigger rate reduction to achieve net tangible benefit. A reduction of 0.5 percent should create enough savings to justify costs within a few years or less. 

Shortening Your Loan Term

Time factors into the cost of a loan. The longer a loan stays open, the more interest the borrower pays to the lender. So, a refinance to shorten a loan’s term will usually produce a net tangible benefit.

This table shows the amount of interest for the same $400,000 home based on three different loan terms. All three terms in this example feature a 7 percent interest rate and a borrower who stays on schedule:

$400,000 principal	Over a 10-year term	Over a 20-year term	Over a 30-year term
Interest collected	$157,321	$344,287	$558,036

These terms charge drastically different amounts of interest when paid off on schedule. Refinancing a 30-year loan into a 20-year loan can produce net tangible benefit, and the benefit is huge: saving around $200,000.

But there’s a catch: To take advantage of these savings, the borrower would have to pay a lot more each month. In the example from above, the principal and interest due each month would be about: 

• $4,640 a month on a 10-year loan
• $3,100 a month on a 20-year loan
• $2,660 a month on a 30-year loan

Shorter loan terms create big monthly payment increases each month for the same home. To get a shorter term, the homeowner would have to prove they have the income to make this larger payment. 

Switching from an ARM to a Fixed-Rate Mortgage

Refinancing from an adjustable rate to a fixed rate for stability can also qualify as a net tangible benefit, Latham said.

Adjustable-rate mortgages, or ARMs, open with a mortgage rate that’s fixed for a set period of time. This fixed period usually lasts three to 10 years. After this fixed rate expires, the loan’s rate will adjust every year based on the market at the time. The payment changes along with it.

Refinancing into a fixed rate creates level payments for the rest of the loan’s term, adding more predictability.

Most lenders will allow an ARM borrower to refinance into a fixed rate even if the fixed rate is higher than the ARM’s current rate. Even with a higher rate, there’s a net tangible benefit because the fixed rate replaces the ARM’s potential to increase its payments.    

Eliminating Private Mortgage Insurance (PMI)

It’s common for mortgage lenders to charge private mortgage insurance, or PMI, premiums to borrowers who put less than 20 percent down. Depending on the size of the loan, PMI could add a few hundred dollars to a house payment each month. 

Typically, refinancing into a loan that does not charge PMI counts as a net tangible benefit. 

Accessing Home Equity Through a Cash-Out Refinance

Cash from a cash-out refinance can count as a net tangible benefit, especially when it pays off other high-interest debt. The tangible net benefit is the financial stability created by debt consolidation.

Even if the cash-out refinance charges a higher interest rate than the home’s current mortgage, the loan could create a net tangible benefit if the new rate is lower than the interest on other debt.

When Refinancing Might Not Provide Net Tangible Benefit

Refinancing may not provide net tangible benefit when the lender charges high upfront fees in exchange for a small interest rate reduction.

All refinances require fees, even if the lender agrees to pay the fees in exchange for a higher rate. The key is to balance fees against the loan’s savings. A refinance breakeven calculator makes comparing immediate costs to eventual savings easier.  

Ideally, a new loan’s savings should break even — its savings should outweigh its costs — within three years. This is ideal because the average homeowner keeps a 30-year loan for only eight years before selling the home or refinancing again. Saving money from the new loan within three years leaves plenty of room to benefit from the loan.  

Buying down a rate through the purchase of discount points can complicate this formula: Discount points trade cash upfront for a lower mortgage rate. For discount points to pay off, the borrower may need to keep the loan longer.  

Determine if Refinancing Is Right for You

The question is not “will I benefit” from the loan but “how much will I benefit” from the new loan? 

To answer this question, do your own math before contacting a lender. Spend a little time with this refinance calculator to find the best-case scenario for saving money long-term or achieving other financial goals.

Then, when you have a target rate and fee structure in mind, you’re ready to take the next step. Start your refinance application with Refi.com today and discover how much you could save.