The Department of Veterans Affairs (VA) recently issued a proposal to update its rules for interest rate reduction refinancing loans (often referred to as “IRRRLs”) to conform with VA loan refinance provisions in the Economic Growth, Regulatory Relief, and Consumer Protection Act, which was enacted in 2018, and the Protecting Affordable Mortgages for Veterans Act of 2019.  Comments on the proposal are due by January 3, 2023.

As the name may suggest, one of the principal uses of an IRRRL is to reduce the interest rate on a veteran’s existing VA loan.  However, successive refinancings of a veteran’s VA loan, often referred to as loan churning, may not be in the best interests of the veteran.  Congress acted to add safeguards to VA loan refinance requirements to address loan churning concerns.  The requirements include:

• A maximum 36-month period for the veteran to recoup the cost of the refinancing.
• The need for the veteran to have made at least six consecutive monthly payments on the existing loan, and the new loan being made at least 210 days after the first payment due date of the existing loan.  These requirements are referred to as “loan seasoning.”
• A minimum reduction in the interest rate from the existing loan to the new loan.
• The need for the new loan to provide a net tangible benefit to the veteran. 

The proposed rule would provide guidance regarding compliance with the existing statutory requirements.

Maximum Cost Recoupment Period

To determine if the maximum cost recoupment period of 36 months is met, the proposal provides for dividing the sum of the fees, closing costs and expenses incurred by the veteran to refinance the existing loan, whether paid in cash or financed, by the dollar reduction in the monthly principal and interest payment, with the result reflecting the number of months it will take to recoup the refinancing costs.  For example, if the applicable costs are $3,600 and the monthly principal and interest payment is reduced by $100, the result would be 36, and the maximum recoupment period would be satisfied.  The costs to refinance would not include (1) the VA funding fee, (2) prepaid interest and amounts held in escrow, and (3) taxes and assessments on the property, even when paid outside of their normal schedule, that are not incurred solely due to the refinance transaction, such as property taxes and special assessments.  If the monthly payment of principal and interest on the new loan will be equal to or greater than the monthly principal and interest payment on the existing loan, such as when the veteran will refinance a 30-year loan into a 15-year loan, the veteran could not be charged any fees, closing costs or expenses, other than the excluded items listed in the prior sentence. 

Loan seasoning

For purposes of the six consecutive monthly payment requirement, the proposal provides that a monthly payment would consist of the principal and interest, amounts for taxes and insurance and similar charges, fees and charges related to late payments, and amounts owed as part of a repayment plan.  Additionally, each monthly payment would need to be made before or in the month in which the payment is due.   Multiple partial payments that at least equal the required monthly payment will count toward the six consecutive monthly payment requirements, if all of the partial payments are made before or in the month in which the monthly payment is due. 

For purposes of the minimum 210-day period, the proposal provides that the note date of the new loan must be at least 210 days after the first payment due date on the existing loan.  The first payment due date on the existing loan is not included in the calculation of the 210-day period, and the note date of the new loan is included in such calculation.  For example, if the first payment due date of the existing loan is June 1, 2022, day 1 would be June 2, 2022, and day 210 would be December 28, 2022.  The IRRRL note date could be December 28, 2022, or later.  The 210-day period would include any days during which the existing loan is delinquent.  However, if the existing loan is modified, the note date of the new loan must be at least 210 days after the first payment due date under the modification.  Additionally, if the existing loan is assumed, the note date of the new loan must be at least 210 days after the first payment due date following the assumption. 

Minimum Interest Rate Reduction

The proposal provides that (1) if both the existing loan and new loan are fixed rate loans, the interest rate must be reduced by a minimum of 50 basis points, and (2) if the existing loan is a fixed rate loan and the new loan is an adjustable rate loan, the interest rate must be reduced by a minimum of 200 basis points.  Additionally, when the existing loan is a fixed rate loan and the new loan is an adjustable rate loan, discount points may be included in the loan only if (1) the lower interest rate is not produced solely from discount points (and the lender will need to provide evidence of this to the VA), (2) the lower interest rate is produced solely from discount points, up to one discount point is included in the loan, and the resulting loan balance (inclusive of all fees, closing costs and expenses that are financed) does not exceed 100% of the property’s value, or (3) the lower interest rate is produced solely from discount points, more than one discount point is included in the loan, and the resulting loan balance (inclusive of all fees, closing costs and expenses that are financed) does not exceed 90% of the property’s value.  Existing VA rules permit a maximum of two discount points to be financed.  Existing VA rules also address when a veteran uses an IRRRL to replace an existing adjustable rate loan with a fixed rate loan, and those rules are not specifically addressed by the proposal.

Net Tangible Benefit

The refinancing must provide a net tangible benefit to the veteran, which the proposal describes as the new loan being “in the financial interest of the veteran.”  The net tangible benefit requirement will be satisfied if (1) the requirements outlined above are satisfied, and (2) the lender provides the veteran with an initial loan comparison disclosure and a final loan comparison disclosure.  The disclosures must include:

• The loan payoff amount of the new loan, with a comparison to the loan payoff amount of the existing loan.
• The type of the new loan, whether a fixed rate loan, traditional adjustable rate loan, or hybrid adjustable rate loan, with a comparison to the type of the existing loan.
• The interest rate of the new loan, with a comparison to the current interest rate of the existing loan.
• The term of the new loan, with a comparison to the remaining term of the existing loan.
• The dollar amount of the monthly principal and interest payment under the new loan, with a comparison to the current dollar amount of the monthly principal and interest payment under the existing loan. 

The lender would need to provide the initial loan comparison disclosure on the same date that the lender provides the initial Loan Estimate under the TILA/RESPA Integrated Disclosure (TRID) rule.  If the lender provides the veteran with a revised Loan Estimate, the lender would be required to provide an updated loan comparison disclosure if there are revisions to the prior loan comparison or the recoupment of the refinancing costs, or there is any other numeric, non-clerical change.  Finally, the lender would need to provide the veteran with the final loan comparison disclosure on the date that the lender provides the Closing Disclosure to the veteran under the TRID rule.  Following the veteran’s receipt of the final loan comparison disclosure, the veteran must certify to the lender the receipt of the initial and final loan comparison disclosures by signing the final disclosure.  For purposes of the disclosure requirements, lenders would be required to use a new standardized form, Interest Rate Reduction Refinancing Loan Comparison Disclosure.

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