Redefining Sustainable Homeownership: Lessons Learned from the VA

A long, hard look at the continuing stability of the VA Loan Guaranty program should be requisite for those helping to reshape and redefine sustainable homeownership in America.

These flexible loans continue to outperform the field in terms of delinquencies and defaults, despite the fact that nine in 10 are no-down payment mortgages. At the same time, VA loan volume has soared the last two years, helping thousands of American service members purchase or refinance amid an increasingly tighter lending environment.

VA loans have more than weathered the subprime crisis and ensuing fiscal tumult. They've emerged as "a model of stability," as Thomas J. Pamperin, a VA deputy under secretary, told a House subcommittee meeting this spring.

To be sure, VA loans remain a small minority when it comes to overall loan volume and market share. But their continued success and stability offers some potential lessons to industry stakeholders working to remake the nation's lending landscape.

Growth and Stability Despite Downturn

Banks, investors and borrower alike are flocking to these government-backed loans given the current economic and lending climate. VA loan volume surged 82 percent in fiscal 2009, as the agency guaranteed more than 325,000 loans valued at about $68 billion.

The agency expects similar totals for FY 2010.

As credit and underwriting requirements have tightened, prospective and existing borrowers have sought refuge in the VA loan program. The agency has long employed flexible-yet-prudent credit and underwriting standards. Its institutional aversion to risk - coupled with its bureaucratic layers of lender oversight - helped insure that primary VA lenders avoided the calamity of subprime and no-paper lending.

Yet, time and again, what draws service members and other qualified borrowers to the program is its signature benefit - the no-down payment mortgage. The concept sounds almost anachronistic, if not downright anarchic, on the cusp of 2011.

Service members in most of the country can secure up to the conforming loan limit ($417,000) without spending a dime out of pocket. The limit exceeds $700,000 in some of the country's costliest corners. There's also no PMI or any type of mortgage insurance premium.

A staggering 90 percent of the VA loans issued in FY 2009 came without a down payment.

Yet, this nearly 70-year-old loan program has proved resilient in the face of default.

At the close of Q2, the delinquency rate for VA loans stood at 7.79 percent, compared to 13.3 percent for FHA loans and 17 percent for subprime loans. Only prime loans - at 7.1 percent - had a lower rate.

VA loans fared even better in terms of foreclosures. Here's a quick look at foreclosure inventory rates during Q2:

• Subprime: 14.4 percent
• FHA: 3.62 percent
• Prime: 3.49 percent
• VA: 2.50 percent

That isn't to say that some service members aren't struggling. Fannie Mae and a host of mortgage companies recently banded together to establish new forbearance options for service members and their families.

But the VA has done a tremendous job keeping veterans in their homes. In fact, the agency helped nearly 72 percent of the families who defaulted on the VA loans in FY 2009 avoid foreclosure.

The continued strength and success of the program is attributable in part to each of its three stakeholders: the government, agency-approved lenders and borrowers themselves. Some aspects of the VA loan program - no down payment mortgages, no PMI, etc. - don't represent a scalable fit when it comes to redefining sustainable homeownership in America. But a handful of policies, procedures and points of view are worth considering....

Four Lessons from VA Loans

The first is the VA's stance regarding debt-to-income ratio and residual income.

Unlike the conventional sphere, the VA is concerned only with the back-end DTI ratio (the VA guideline is 41 percent). But the agency also puts significant stock in residual income, the amount of money remaining at the end of each month after subtracting all major expenses. The agency has well-established residual income guidelines that vary by region and dependent status.

For example, a prospective New Jersey borrower with a family of four would need to have at least $1,025 in residual income each month in order to satisfy the VA. And that's assuming the borrower's DTI ratio is at or below that 41 percent guideline. Prospective borrowers with a DTI ratio above the guideline must clear an additional hurdle - their residual income must be at least 120 percent of the guideline.

An unacceptable residual income level will kill a loan application out of the gate. Enacting standards that incorporate residual income can help boost the likelihood that borrowers have the financial ability to meet their obligations each month.

The second policy is the VA's appraisal process. There's already been movement in this direction, but it's worth reiterating. The VA has served as a standard bearer for neutral, above-board appraisals. VA appraisers are assigned randomly on a rotating basis and monitored frequently by agency officials. This degree of oversight and objectivity has helped  ensure home values are in line with market realities.

VA appraisals also put a premium on the health and safety of veterans and their families.

The third concept worth considering is the VA's foreclosure avoidance mechanisms. The agency is committed to helping service members stave off default. VA-approved lenders are required to explore options to foreclosure, from forbearance and modifications to payment plans and short sales. VA officials even created an incentive program to further entice mortgage servicers to exhaust alternatives to foreclosure.

The VA will also intervene directly with borrowers to find a solution.

The fourth and final idea is more difficult to mimic. Order, structure and obligation are deeply ingrained tenets for most service members. That conditioning tends to follow them throughout their lives, including when the time comes to follow through on structured loan payments. Part of remaking the concept of sustainable homeownership is helping borrowers comprehend what's truly sustainable when it comes to their expenses, their income and their ability to meet financial obligation.

Prospective borrowers don't need to go through boot camp or basic training in order to gain that perspective. But the average service member's "strong sense of commitment," as Mr. Pamperin described it this spring, represents the kind of borrower ethos that the industry - and the market as a whole - needs in order to move forward.