The Federal Housing Administration (FHA), the Veterans Administration (VA), and the government-sponsored enterprises (GSEs) each have their own rules for refinancing mortgages. The FHA and the VA allow for streamlined refinances on mortgages for which they already own the risk. This process prevents a cumbersome and costly re-underwriting. The GSEs do not. The FHA and the VA have seasoning requirements on their mortgages before the mortgages can be refinanced, but the GSEs do not. Both the VA and the FHA have net tangible benefit tests to measure whether the refinance is in the borrowers’ interest; these tests fail to adequately protect borrowers. In addition, government agencies and the GSEs have penalties for lenders whose loans prepay faster than most other lenders’ loans. These penalties can impede refinancings that put the borrower in a stronger financial position.

Why This Matters

We believe a unified set of rules regarding when streamlined rate-term refinances are permitted would benefit borrowers, investors, and lenders. These rules would protect borrowers from refinances that are not in their financial interest; give lenders the confidence to solicit borrowers for refinancing when they qualify, without worrying about relative prepayment rates; and give investors more certainty about prepayment rates. Moreover, this is an opportune time to make these changes, as mortgages interest rates are higher than the rates that most borrowers pay, minimizing any near-term disruptions.

Key Takeaways

We make the following recommendations:

• There should be one consistent set of rules across the GSEs, the FHA, and the VA, with one net tangible benefit test. We recommend eliminating borrowers’ ability to roll closing costs into the loan amount—these closing costs would be either paid in cash or rolled into the rate. We recommend requiring a 50 basis-point savings between the old note rate and the new one. Doing so would give the borrower a better picture of the true costs of a refinancing. In addition, by leaving the loan amount constant, the risk to the insurer or guarantor unambiguously drops. Finally, servicers that follow the new net tangible benefit test should be given a safe harbor, thereby freeing them to solicit borrowers that meet the new requirements who might not have otherwise thought to refinance. The seasoning requirement would be eliminated.
• The Consumer Financial Protection Bureau should allow the GSEs to offer a streamlined refinance program; this means exempting certain rate-term refinances from the ability-to-repay rule.
• Phase out loan-level pricing adjustments, mortgage insurance premiums, and VA funding fees. We recommend these fees be set at 100 percent if refinanced immediately (i.e., collected again) but decline to zero if the mortgage has been outstanding for two years. The two-year phaseout discourages borrowers from rolling these fees into the rate on the initial mortgage and then refinancing immediately, even when rates have not changed.

We hope this brief will generate a robust discussion on the need to rationalize refinance policies and how best to do so.