Veterans Affairs mortgage program avoids the pitfalls of other lenders

August 19, 2011

Imagine a mortgage program that seems to defy many of the lessons of the housing bust:

• 91 percent of its borrowers make zero down payments.

• Loan amounts go well into the jumbo range — to $1 million and sometimes above, even with little or nothing down.

• Credit standards are flexible and generous. Underwriting rules encourage loan officers to look for ways to approve applications rather than to reject them.

• Mortgage originations are up — almost triple what they were just three years ago — and are on track this year to exceed 2010’s volume. The rest of the loan industry, by contrast, is down by anywhere from 25 percent to 30 percent.

You might assume that any home loan program with come-ons like these must be swimming in bad mortgages, loaded down with serious delinquencies and foreclosures. Yet this one, which gets relatively little attention in the media, has better mortgage performance than FHA and is comparable with some “prime” loan operations that have far more stringent credit rules.

Can you name this financing phenom? It’s the Department of Veterans Affairs’ home loan guaranty program. At a time when federal regulators are considering imposing a 20 percent minimum down payment requirement for most conventional mortgages, the VA program, which is restricted to veterans, offers important insights on how to get families into homes with little cash upfront, and to keep them out of foreclosure, even in tough economic times.

What’s in the special recipe at the VA? Tops on the list: a combination of loan features that are by far the most attractive available in the current market. While the FHA program also allows minimal down payments — 3.5 percent — the VA goes to zero even if you need a jumbo-sized loan.

Unlike low-down-payment loans you can get from Fannie Mae and Freddie Mac and FHA, there are no monthly mortgage insurance premiums. VA loans do have an upfront “funding fee” that varies according to the down payment and other criteria. Currently this fee ranges from 2.15 percent for zero-down borrowers to 1.25 percent for applicants putting down 10 percent. Most applicants opt to roll the fee into the loan amount and finance it over time.

The VA imposes no credit score minimums. Its average FICO score is 708, compared with the 750 to 770 scores typical for Fannie Mae- and Freddie Mac-backed conventional mortgages at the best interest rates. It does, however, require underwriters to look closely at credit bureau reports and documented income to ensure that borrowers have the ability to repay their loans.

The agency is exceptionally flexible on seller contributions to help buyers pay closing costs, escrows and loan origination charges -- more lenient, in fact, than any other national program. That, in turn, can significantly lower the net cash outlays needed from borrowers at closing.

The VA also stretches debt-ratio norms when needed to help creditworthy, income-strapped borrowers get into a home. Though the official “back end” ratio of total household monthly debt to household income is 41 percent, lenders say VA will let them push this higher, even to 55 percent, on a case-by-case basis.

With all these accommodations to borrowers, how is it that VA’s 90-day delinquency rate in the latest study by the Mortgage Bankers Association is 2.2 percent while FHA’s is 4.8 percent? Or its total seriously delinquent plus in-foreclosure rate for borrowers is 4.5 percent, against FHA’s 8.04 percent and the conventional prime market (Fannie and Freddie) at 4.3 percent?

Michael Fratantoni, the mortgage bankers association’s vice president for research, says that the VA’s record “is remarkably good, given that they’re allowing first-time buyers to get in with no down payments,” which is traditionally linked to high defaults and foreclosures.

Michael Frueh, the VA program’s acting director, says the key to the agency’s quiet success is its almost paternalistic emphasis on servicing its 1.5 million borrowers — moving early and quickly to intervene at the slightest hint of payment problems.

“At the end of the day, we are veterans’ advocates,” he said in an interview. “We exist solely to help them,” not only to afford to finance their homes but to remain in them. In the past three years, the VA has instituted industry-leading techniques such as requiring lenders to establish “single point of contact” servicing systems, where customers deal with one person about their mortgage issues, rather than anonymous multitudes.

Could this mindset — intensive “advocacy” servicing as a borrower benefit built into the loan itself — be duplicated in other segments of the mortgage market?

Maybe the real question is: Why not?

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