HMDA Refinance vs. Cash-Out Refinance
In this HMDA video, Adam explains when to use a "refinance" code vs a "cash-out refinance" code and explains that a cash-out refinance is just a subcategory of a refinance. He also discusses which code to use for business purpose loans.
Video Transcript
The following is a transcript of this video.
This Compliance Clip is going to focus on the difference between a refinance and cash-out refinance under the Home Mortgage Disclosure Act. This video does apply only to HMDA reporters. Now, the rule for this is found in 1003.4(a)(3) under the Rules for Loan Purpose. The rule states “Report whether the covered loan/application is a home purchase loan, refinancing, a cash-out, or for an other purpose.” So, that is the rule.
The question, however, is what is the difference between a refinance and a cash out refinancing? Right, this is a very good question. Now the answer is found in the commentary to this rule. It's found in Comment 2 to part 1003.4(a)(3), which is the citation of loan purpose rules, under Regulation C.
Comment 2 talks about the difference between a refinance and a cash-out refinance. Specifically, it gives three different scenarios to explain what they want that all depend on if a financial institution has a defined cash-out program. The first thing you have to do is determine if you have a program, whether it's an in-house program or a secondary market program where there is a cash-out program, something where you define the difference between a refinance and a cash-out refinance.
For example, in the secondary market, they often have standards that say you can have a refinance that is not a cash-out and still give a check to the borrower at closing as long as it is an amount less than $2,000 or 2% of the loan amount. Let me say that again, your customer could actually get a check on a secondary market loan for $1,000 at the closing table if the secondary market has a standard that says it's still a refinancing but not a cash-out product, as long as that cash coming to the customer is less than $2,000 or 2%. A lot of secondary market programs have that $2,000 or 2% rule. So as long as you're within the guidelines, they can get some money back and it's still not considered a cash-out refinance.
Now why would that matter on the secondary market? Well, there's different pricing on the secondary market for cash-out versus non-cash-out. They're gonna pay a little bit more because the risk is increasing on a cash-out product. That's the main reason why they have that $2000, 2% limit because they don't consider that to be cash-out where more amounts greater than that are. So that's what we're looking at - if you have a defined program like that.
Let's go through these three scenarios to help us to understand how we report that on our HMDA LAR.
The first scenario talks about an investor loan program, such as on the secondary market. So if the guidelines of the loan program you have, say that a loan is a cash-out loan and the loan would have been a, been following those standards, basically meaning the amount was more than, for example 2000 or 2%, then you report it as a cash-out loan. So as long as the guidelines say it's a cash-out loan, you adhere to the guidelines, then you report it as a cash-out loan under your investor standards.
For an in-house loan, again, if you have defined standards, maybe you've adopted the same standards as the secondary market with that $2,000, 2%, and the amount is less than your standards for a cash-out loan, you would report it as just a refinance. Even if they got a little bit of money back, but it didn't meet that threshold to put it into a different product.
Now, I will tell you from experience, a lot of community banks and credit unions do not have a defined cash-out product for in-house loans. So, that leads us really to the next line item, the next scenario provided in the commentary where they say if your guidelines do not differentiate between cash-out and refinancings, then you report all loans in that product as refinancings. So whether they get no money back or $50,000 back, if you don't define the difference between a refinancing and a cash-out refinancing under your product guidelines, then you report everything as a refinancing.
I tend to think there's another scenario that they left out. Specifically, if we go back and look at this last scenario, it's talking about if your guidelines don't differentiate. But my question becomes, what if a bank does not have in-house guidelines, but does have secondary market guidelines? Now, in the secondary market guidelines, of course, we're going to report it the way the guidelines state, but what do we do for in-house loans? This is actually debatable, and I've had some debates with other HMDA gurus on this specific topic.
Now, the guidance does not specifically address this situation, and I've heard where other gurus have said you report everything as not a refinance on your in-house loans, but I say, if you don't define it, you're gonna have to make a determination on whether you report them as re-refinancings or cash-out refinancings. Probably you're not gonna list them as cash-out, but because you don't have a standard to go off of, but here's what I'm getting to: my recommendation is that you define your in-house guidelines.
If you are a bank that does sell loans on the secondary market, it does have guidelines to differentiate between cash-out refinances and not cash-out refinance products. I would, if I were you, I would recommend defining your in-house guidelines to differentiate between cash-out and non-cash-out. This could be as simple as saying, did they get a check or not? If they got a check, it's a cash-out. If they did not get a check, it is not a cash-out and reported as refinancings.
Now is that required? While some of the other HMDA gurus say no, I think it is the best practice. It will ensure compliance. If you've defined the guideline and stick with it, there is no debate whatsoever. If you don't define it, is it okay? Probably, but the easiest and most conservative approach would be to define it.
That's all I have for today.