One of the biggest challenges that came with the January 1, 2018 HMDA changes relates to the difference between a refinance and a cash-out refinance. On the surface, it would not seem to be that difficult but the specifics can actually get quite complicated. Therefore, it is imperative that each HMDA reporter fully understand the difference between a cash out refinance and a refinance.
Understanding How a Refinance Fits in the HMDA Purpose Hierarchy
In order to fully understand the difference between a refinance and a cash out refinance, we must first look at how each of these fit inside the HMDA purpose hierarch. To explain, the HMDA purpose hierarchy is the term used to describe the order of dominance - or pecking order - that each purpose has compared to the others. In other words, if an application has multiple purposes, one purpose is going to trump the others and, therefore, that purpose will be reported on the HMDA LAR.
The HMDA hierarchy order starts with the purpose of a purchase, followed by both a refinance or cash out refinance, followed by the purpose of home-improvement, and at the end of the hierarchy is the other purpose. What is important to understand when looking at the difference between a cash out refinance and a refinance is that both purposes are second in line in the HMDA hierarchy. In other words, an application is only going to have one purpose or the other - both types of refinance are included the the “refinance” level of the hierarchy.
I like to view it this way: a purpose is always ranked #1 in the hierarchy. A refinance is #2(a), while a cash out refinance is #2(b) - it is one or the other, never a question of both. A home-improvement purpose is ranked #3 and the other purpose is ranked #4.
The bottom line is that an application could never have both a purpose of a refinance and a purpose of a cash out refinance - it’s either one or the other - and this is why these purposes are considered to both be second in line in the HMDA hierarchy.
The Difference Between a Refinance and Cash-Out Refinance for HMDA
Now that we understand that both a refinance and a cash out refinance fall into the same category of the HMDA hierarchy, we must now understand the difference between the two. In simple terms, and application will be reported as either a refinance or a cash out refinance depending upon the products and procedures of a specific financial institution. This means that each financial institution may have a slightly different definition as to what is a refinance or a cash out refinance. This, of course, can easily lead to confusion from auditors and examiners, so it is imperative that each financial institution fully understand how this applies to their organization.
In order to fully understand how this works, a HMDA reporter must look to the commentary to Regulation C. The commentary provides three different examples to help financial institutions determine which purpose to use. Now, rather than just quoting the examples in the commentary, let me try to explain how this actually applies. To do this, we need to look at three different scenarios:
When a financial institution has clearly defined cash out and non-cash out products
When a financial institution does not have any defined cash-out products
When a financial institution has a mix of defined and not defined cash-out products
Institutions With Clearly Defined Refinance Products
The biggest factor to consider in differentiating between a refinance and a cash out refinance is whether an institution defines a cash out product differently than a non-cash out product. A clear defining of products like this is a practice utilized by the secondary market as there is often a better rate available for a refinance that does not offer cashback. Basically, secondary market loans will have parameters to determine if an applicant qualifies for either a refinance, or a different product of a cash out refinance.
For example, a refinance on the secondary market may be defined as any loan where the customer receives less than the lesser of $2,000 or 2% of the loan amount in cash back at closing. This means that even if a customer gets a check for $500 or even $1,999 at closing, the product still qualifies as a non-cash out product under the products guidelines. Therefore, this application would be reported as a refinance - and not a cash-out refinance - on the HMDA LAR even though the customer received cash back at closing, because the loan qualified as a non-cash out product by clearly defined guidelines.
What all of this means is that in determining whether a loan is reported on the HMDA LAR as a refinance or a cash out refinance, a financial institution will look to the product guidelines and report each loan accordingly. This is actually quite simple when a financial institution’s products have a clearly defined difference between a cash out product and a non-cash out product.
If, however, a financial institution does not have separate guidelines for a refinance and a cash out refinance, the rules will apply a bit differently.
Refinance For Financial Institutions With No Defined Products
The next situation we need to look at in order to determine if an application will be reported as a cash-out refinance or a refinance is when a financial institution, such as one that does not sell any loans on the secondary market, does have different cash out and non-cash out refinance products. The commentary to Regulation C explains that if a financial institution does not differentiate between a cash-out refinance and a non-cash out refinance, then all loans are to be reported as a refinance (rather than a cash-out). In layman’s terms, if your financial institution doesn’t have different products for a refinance with no cash out and one that does, then your institution should report all applicable entries on the HMDA LAR as a refinance. The result of this is that these institutions will never report a cash out refinance on their LAR, even if they originate loans where the borrower gets funds back at closing.
HMDA Cash Out or Refinance for Institutions with Mixed Products
While the first two scenarios are fairly simple, the rules can be a bit more challenging when a financial institution offers both products that differentiate and those that don’t differentiate between a cash out and non-cash out refinance. The way the examples in the commentary are worded, the guidance actually leaves some confusion as to how a financial institution - which offers both defined cash out products and some that do not - should report their products on the HMDA LAR. For example, a financial institution may offer both loans on the secondary market with defined cash-out products as well as in-house products that don’t differentiate between a cash out and non-cash out refinance.
To explain this, let’s look at the third example from the commentary:
“iii. Assume a financial institution does not distinguish between a cash-out refinancing and a refinancing under its own guidelines, and sets the terms of all refinancings without regard to the amount of cash received by the borrower at closing or account opening, and does not offer loan products under investor guidelines. In this example, the financial institution reports all covered loans and applications for covered loans that are defined by § 1003.2(p) as refinancings for purposes of § 1003.4(a)(3).”
The challenge with this example is that it assumes that a financial institution sets the terms of “all” refinancing without regard to the amount of cash out received by the borrower. As the commentary does not address situations where some products are defined and some are not, there could be confusion as to how to report loans, especially in-house loans that receive cash back greater than the secondary market product standards.
As a matter of practical application, most financial institutions will most likely just report all in-house products as refinancings and then report their secondary market loans as refinacings or cash out refinancings, depending on the defined product and amount of cash out received.
That said, if a financial institution wants to take a more conservative approach that will ensure compliance, there is a best practice that will do that: to define a difference for a cash out and non-cash out product for all in-house loans. This could be something as simple as utilizing the same parameters used for secondary market products, or could just include a differentiation of whether a borrower receives a check at closing. Either way, a clearly defined product will help to avoid potential criticism for this gray area and ensure compliance going forward.
The Regulation and Commentary for a HMDA Refinance vs Cash-Out Refinance
As we often do in our articles, I want to leave you with the actual rule and commentary so that you don’t have to just take my word for this, but can see for yourself where my explanation is coming from.
From Regulation C:
(3) Whether the covered loan is, or the application is for, a home purchase loan, a home improvement loan, a refinancing, a cash-out refinancing, or for a purpose other than home purchase, home improvement, refinancing, or cash-out refinancing.
And from the commentary:
2. Purpose—refinancing and cash-out refinancing. Section 1003.4(a)(3) requires a financial institution to report whether a covered loan is, or an application is for, a refinancing or a cash-out refinancing. A financial institution reports a covered loan or an application as a cash-out refinancing if it is a refinancing as defined by § 1003.2(p) and the institution considered it to be a cash-out refinancing in processing the application or setting the terms (such as the interest rate or origination charges) under its guidelines or an investor's guidelines. For example:
i. Assume a financial institution considers an application for a loan product to be a cash-out refinancing under an investor's guidelines because of the amount of cash received by the borrower at closing or account opening. Assume also that under the investor's guidelines, the applicant qualifies for the loan product and the financial institution approves the application, originates the covered loan, and sets the terms of the covered loan consistent with the loan product. In this example, the financial institution would report the covered loan as a cash-out refinancing for purposes of § 1003.4(a)(3).
ii. Assume a financial institution does not consider an application for a covered loan to be a cash-out refinancing under its own guidelines because the amount of cash received by the borrower does not exceed a certain threshold. Assume also that the institution approves the application, originates the covered loan, and sets the terms of the covered loan consistent with its own guidelines applicable to refinancings other than cash-out refinancings. In this example, the financial institution would report the covered loan as a refinancing for purposes of § 1003.4(a)(3).
iii. Assume a financial institution does not distinguish between a cash-out refinancing and a refinancing under its own guidelines, and sets the terms of all refinancings without regard to the amount of cash received by the borrower at closing or account opening, and does not offer loan products under investor guidelines. In this example, the financial institution reports all covered loans and applications for covered loans that are defined by § 1003.2(p) as refinancings for purposes of § 1003.4(a)(3).
