A recent crackdown on loan churning promotes transparency, but more education is needed.
By Kraig Spence, manager, Churchill Mortgage’s Columbia, Maryland, branch |
Housing may be one of the strongest sectors of the economy right now, but some 10 years ago the mortgage meltdown and resulting financial crisis tested the very fabric of that market. In the aftermath of that crisis, many mortgage originators found safe haven in government-backed mortgages, such as those offered through the U.S. Department of Veterans Affairs (VA) — which makes available a number of purchase, refinance and streamlined financing options.
There are plenty of advantages with VA loans. For active-duty military personnel and veterans, the loan programs can be less costly than conventional loans. For mortgage originators and lenders, VA loans are attractive because historically they have had low loan-delinquency rates and include protections against defaults.
The Veterans Affairs (VA) Home Loan Guaranty Program is an entitlement for active and honorably discharged military service members. Financing is available for up to 100 percent of a home’s value for both purchase and refinance transactions.
For veterans with low credit, VA loans can be especially beneficial as they provide additional flexibility and can be less costly in comparison to conventional loan products. Unlike conventional loans, the VA loan requires no mortgage insurance, making it a cost-effective option for buyers with smaller down payments.
There’s been one notable problem with the VA program of late, however. Reports emerged more than a year ago about VA lenders aggressively soliciting veterans to refinance their loans as a way to generate fees. There’s been a push to stop this and prevent it in the future. Those mortgage originators and lenders who abide by the rules of VA loans, however, will find a great program.
The price to originate a VA loan is called the funding fee and can be financed on top of the base loan. It can range anywhere from 0.5 to 3.3 percent of the loan amount, depending on product type and downpayment amount. A $100,000 mortgage would involve a funding fee of anywhere from $500 to $3,300, for example.
A funding fee of up to 3.3 percent is charged for all VA cash-out refinances — depending on the nature of the individual’s military service and whether it is the first use of the program. Veterans using a VA purchase-loan program for the first time pay up to a 2.4 percent funding fee (but less if a downpayment of 5 percent or more is made), while subsequent uses of the program require up to a 3.3 percent funding fee (again, less if a down payment is involved).
For recipients of VA disability compensation, the funding fee is waived. This funding fee is nonrefundable and is held in reserve by the VA as an insurance policy of sorts. When a loan defaults, the VA taps into this reserve fund to help cover lender losses.
Layers of security
Ginnie Mae provides liquidity to the government mortgage market, including VA loans, in a similar way that Fannie Mae or Freddie Mac does for the conventional loan market. Ginnie Mae helps to reduce the costs of mortgages by guaranteeing securities underpinned by VA and other government-backed mortgages.
Becoming a Ginnie Mae mortgage issuer is the apex for a lender specializing in government loans, as it results in fewer guideline overlays and, potentially, increased profitability. After a lender has funded a mortgage, it gets packaged into a loan secured with other similar products and sold with Ginnie Mae’s guarantee in the secondary market, with an expectation of a profitable return for investors.
“ Ginnie Mae’s regulatory actions and the VA’s guidelines send a strong message to the mortgage industry: Steer clear of unscrupulous lending tactics. ”
VA loans do not carry a high default rate and have historically been a lucrative capital-market investment. Active-duty service members are paid a tax-free monthly basic allowance for housing, which typically covers mortgage payments. And the inherent risk of less equity or lower credit scores is mitigated by the VA loan guarantee, which typically covers 25 percent of the borrowed money in case of default.
If a $200,000 mortgage defaults, the VA covers $50,000 of the loss, thereby drastically reducing the loss exposure on a per-loan basis. VA loans tend to be prone to quicker payoffs because active-duty military borrowers may sell homes as a result of being relocated. In these cases, however, it is likely that active-duty service members will purchase another home at their new location, once again using VA-backed financing.
For years, the mortgage industry has thrived in an environment of low-interest rates, creating fertile origination ground for legitimate rate-reduction opportunities. The post-recession era also opened its doors to lenders, and brokers, searching for a new niche or identity in the marketplace, and the VA loan provides that opportunity.
Many of the higher-rate mortgages that are targeted for refinancing originate from lenders specializing in cash-out VA mortgages. Veterans should be very careful in situations such as these, as the rates on the new refi loan can be higher and coupled with additional origination fees. A veteran could end up paying thousands of dollars in fees to refinance a loan that actually increases their current mortgage rate, for example. These cash-out mortgages are typically on 30-year loans which means the remaining loan term that is refinanced also is re-amortized and extended 30 years.
The mortgage payments may increase by hundreds of dollars a month, but there can be a cumulative monthly payment reduction realized by paying off unsecured debt as well. In other words, a mortgage payment may actually increase $300, but credit cards costing $800 per month are paid off with the cash taken out via the refi, resulting in a perceived net payment reduction of $500 per month. The originating lender may place emphasis on the latter, even advising that the money saved on credit card debt be used to pay off the mortgage quicker.
VA lenders who pursue these practices typically charge higher interest on these loans and originate at costs well above average market rates. The lenders may point to their borrower’s lower credit scores or zero equity mortgages as reasoning for the pricing, but the higher rates also encourage other lenders to pursue these loans.
Another type of loan that has been the target of an alleged abuse, which is referred to as loan churning, is the VA Interest Rate Reduction Refinance Loan (IRRRL), which is a reduced-cost refi program with streamlined documentation requirements. The program is offered at a much lower funding fee, only 0.5 percent of the total loan amount, and allows the veteran to take advantage of improved interest rate markets or opportunities for affordable term reductions. What is important in the IRRRL calculation is that the “recoupment” point (how long it takes to recover the cost of the refi) is identified, explained and understood by the veteran before deciding to move forward with the loan.
In some cases, the lower-rate IRRRLs are being originated by a lender who initially placed the veteran in a higher-rate, cash-out mortgage, which is especially concerning. In many of these alleged loan-churning cases, the veteran also was sold a much lower rate by a previous lender that actually carried a net tangible benefit. Remember, the veteran needs to be in a VA loan in the first place to qualify for the rate-reduction loan.
In recent months, the VA and Ginnie Mae have drafted guidelines requiring lenders to provide additional information to veterans so they can make better-educated decisions as to whether the cost of an IRRRL is worth the end-benefit. More specifically, the VA wants lender refi charges and rates compared with the tangible benefits produced by the loan.
The VA has strict regulations regarding how long it should take to recoup the cost of a refi in order for the mortgage to pass a net tangible benefit test. Not only does this make the transaction as transparent as possible, but it also protects the markets in which these loans are securitized. The VA also is concerned that veterans may be paying more in fees and costs to obtain that lower refi rate, while at the same time, not receiving enough of a benefit from doing so.
Without higher-cost refi mortgages, there would likely be a rapid decline in the alleged loan churning that has been taking place. That is why earlier this year Ginnie Mae issued a notice to a handful of lenders to curb this potentially abusive practice. In April, Ginnie Mae even expelled some lenders from its primary mortgage-bond program because of concerns over loan churning. Ginnie Mae’s regulatory actions and the VA’s guidelines send a strong message to the mortgage industry: Steer clear of unscrupulous lending tactics.
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The VA loan program should not be abused, or misused, at the veterans’ expense. It is not always the right product, and oftentimes, it may be more financially sound to select a conventional loan. The recent steps taken by the VA and Ginnie Mae to curb unscrupulous lending practices are a step in the right direction, but more borrower-focused education is needed to help our veterans make the best mortgage decision possible.