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Giving it 100 percent. (Residential Production).

The outlook is unclear as to whether 100-percent-loan-to-value (LTV) mortgages can dramatically expand homeownership for minorities and lower-income families. Even so, more and more lenders are offering this product both for first-time homebuyers and high-end customers.

THE BARRIERS TO HOMEOWNERSHIP HAVE BEEN CRUMBLING SLOWLY and steadily for more than a decade. As a result, homeownership rates rose from 63.9 percent of all occupied housing in 1991 to 67.5 percent in 2001. No doubt years of falling interest rates and the long economic expansion from 1991 to 2001 were key ingredients to this boon. * Yet, some of the credit for this progress surely goes to product innovations and rising expertise in evaluating nontraditional borrowers both in the private sector, at the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, as well as at the Federal Housing Administration (FHA). Lower down payments, allowed contributions from third parties, higher debt-to-income ratios, acceptance of nontraditional credit histories and other innovations have made homeownership more readily affordable and attainable for some minorities and low- and moderate-income earners.

The most significant barrier--the requirement for a down payment--is now falling in the conventional mortgage market outside the FHA and Department of Veterans Affairs (VA) loan programs. Such loans are now available from hundreds of lenders for those with sufficiently good credit and, in some cases, with financial counseling about homeownership. The rationale behind offering this mortgage product is clear. "It's one thing I've heard repeatedly," says Julie Gould, vice president of housing impact at Fannie Mae. "Money for down payments is the largest single barrier to homeownership."

Both Fannie Mae and Freddie Mac are now offering the 100-percent-loan-to-value (LTV) mortgages on a limited basis. Another leading innovator in this market is mortgage insurer United Guaranty Residential Insurance Co., Greensboro, North Carolina, which introduced a 100-percent-LTV product in 1998. Through a funding subsidiary, United Guaranty has created a program that now offers 100-percent-LTV mortgages through 350 lenders. This product, however, is aimed at borrowers at all income levels with excellent credit scores rather than at low-income borrowers with average to good scores.

Despite the new offerings, so far the incidence of 100-percent-LTV mortgage lending remains fairly rare in the conventional market. Nearly all participants we interviewed in the 100-percent-LTV conventional lending market would not divulge how much volume they have done with the product. United Guaranty estimates the conventional side to include a total of roughly $10 billion. That would put the total market for 100-percent-LTV-and-above loans at an estimated $50.8 billion, including the still-dominant FHA, which did a projected $12.4 billion in 100-percent-LTV lending last year, and the VA, which did $28.4 billion.

Making the case for 100 percent

The 100-percent-LTV primary mortgage is a logical next step in the conventional market after the success of the 97-percent-LTV mortgage that has been around since the mid-1990s, according to Angelo R. Mozilo, chairman, chief executive officer and president of Countrywide Credit Industries Inc., Calabasas, California.

"Fannie, Freddie and the FHA have done a very good job of lowering the barriers to homeownership" by lowering the down payment and the income required to get a mortgage, Mozilo says. "They continue to stretch those limits." Yet all three could do a whole lot more by offering no-down-payment programs to as large a market as possible by removing all limits on the number of loans that can be funded this way, says Mozilo.

Mozilo justifies the need for 100 percent mortgages as follows: "My contention is that a 3 percent down payment is no different than a zero percent down payment in terms of the quality and integrity of the loan." He acknowledges that the argument for at least a 3 percent down payment mortgage is that homeowners have something to lose if they walk away from the mortgage. "If they lose a job, 3 percent down is not sufficient to save the house," says Mozilo. That's because they cannot get anything out of the house if they sell it, and they do not have enough equity to borrow against it, he adds.

The lack of a sufficiently broad-based 100-percent-LTV loan program, then, means that "those without 3 percent are foreclosed from the opportunity to own [a] home," Mozilo says. And even for low-income families that have accumulated a 3 percent down payment, Mozilo thinks it would be better for potential low-income homebuyers to set aside that 3 percent down payment as a reserve to deal with potential problems. Such a reserve could offset temporary unemployment, unexpected medical bills and emergency home improvements and enable the family to keep their home.

Mozilo insists his argument is not based strictly on business instinct or his hopes to expand homeownership, but is supported by existing data. He points to the comparative performance of zero-down-payment loans at the VA and the 3 percent down loans at FHA as evidence to support expanding the availability of 100-percent-LTV mortgages.

"You'll see there is an equal or better performance on the VA side on delinquencies," he says. Indeed, the entire FHA portfolio of loans, including those with more equity than 3 percent, have consistently underperformed those at the VA. In the third quarter of 2001, for example, the delinquency rate for all FHA loans past due was 11.36 percent and it was 8.11 percent at the VA. This is the case even though in the VA loan program 90 percent of loans are 100-percent-LTV or higher.

Even though FHA delinquency rates have been rising, Mozilo points out that the EHA still makes money. He suggests that both Fannie Mae and Freddie Mac "have taken away business from FHA as they lower the bar" on down payments and made their underwriting more flexible for affordable lending products. As a result, he thinks that the FHA and Ginnie Mae "are adversely selected." Ginnie Mae guarantees the securities backed by FHA and VA mortgages. The solution for the FHA, according to Mozilo, is to become more creative with devising ways for "getting people over the hurdles to homeownership" and come up with new products that will better compete with those of Fannie Mae and Freddie Mac.

If Fannie Mae, Freddie Mac or the FHA were to successfully make 100-percent-LTV loans a more substantial part of their lending, it could form the basis of the most ambitious effort yet to expand homeownership among low- and moderate-income families, Mozilo says.

Conflicting data

A look at government loan databases reveals that lending volume in the high-LTV market may have hit a plateau, especially for home purchases. According to the Federal Housing Finance Board (FHFB), which tracks segments of the home-purchase loan market, the number of loans that are higher than 90 percent LTV appears to be slowly declining in recent years--even as delinquencies and defaults are rising modestly.

The 90-plus-percent-LTV market represented 9 percent of all single-family purchase mortgages issued in 1991, according to the FHFB. That number jumped to 25 percent in 1994 and 27 percent in 1995, and then stayed at 25 percent for three years. In 1999, it dropped to 23 percent and, in 2000, it slipped to 22 percent. FHFB sources say the final number for 2001 is likely to be close to 21 percent. High-LTV lending also had a surge in the 1980s, peaking at 27 percent of the business in 1984 before falling back sharply to single digits.

FHFB's survey includes loans from the last five business days of the month from lenders, and does not include de the FHA and VA in its database or refinancings from any source.

When refis are included in the mix, a slightly different trend emerges showing a gradual gain in high-LTV lending in recent years. This trend can be seen in the 32-million-loan database of LoanPerformance (formerly Mortgage Information Corporation), San Francisco, which tracks loan volume and loan performance.

LoanPerformance's database includes refis, VA and FHA loans in addition to home-purchase loans, so it covers a larger universe than FHFB's. According to LoanPerformance, the number of loans that are greater than 90 percent LTV has been slowly increasing over the past four years. In 2001, the number of loans in the greater-than-90-percent-LTV category reached just less than 20 percent, co pared with a 1998 level of 17.2 percent of total loans.

LoanPerformance also breaks down its data into more refined product classes than FHFB, including three categories for loans greater than 90 percent LTV. A look at these categories shows that the gains in the high-LTV market have come almost entirely in the group of loans that are greater than 95 percent LTV and up to 100 percent LTV. This category had about 6.2 percent of all loans in 1998 and about 8.7 percent of all loans in 2001 (see Figure 1).

Delinquency and default rates slip slightly

As always, delinquency rates will be the key to whether this market shrinks, holds its own or grows. In the third quarter of 2001, signs emerged that the weakening economy was starting to take its toll. Not only had FHA delinquencies of 30 days or more risen, but industry insiders who keep tabs on the conventional market report that some segments of that market have seen delinquencies of more than 30 days rise to more than 12 percent.

The VA reports that during the third quarter of 2001, 8.11 percent of its loans were past due 30 days or more, up from 6.44 percent in the first quarter of 2000. The mounting number of layoffs in the fourth quarter of 2001 and the first quarter of 2002 will pose an even more difficult test for loan performance.

Closing the gap in homeownership between whites and minorities

The players that enthusiastically entered the high-LTV market are upbeat about its potential. Some major lenders also see great opportunities, especially Countrywide's Mozilo. He would like to see Fannie Mae and Freddie Mac embrace the 100-percent-LTV loan market wholeheartedly and expand it as a major part of their regular business.

The potential market of would-be users of a broad new 100-percent-LTV mortgage program would certainly include a sizable share of African-American and Hispanic households. The share could even be as high as one-fourth of the nation's combined Hispanic and African-American population. This population segment corresponds roughly to the gap in homeownership rates between whites and minorities. There have been slow, steady--but significant--gains in homeownership rates by minorities over the past decade, according to data collected by the U.S. Census Bureau. But Mozilo and others believe the key to further gains may lie in the no-down-payment product.

In the third quarter of 2001, homeownership among whites was at a peak of 74.6 percent and stood at 47.5 percent for African Americans and 48.1 percent for Hispanics. In 1991, by comparison, homeownership for whites stood at 69.4 percent; for African Americans, 42.6 percent, and for Hispanics, 41.2 percent.

Despite a decade of gains, the gap between the ownership rates for African Americans and whites in 2001 remained almost the same as it was in 1991: 27.1 percentage points versus 26.8. However, the gap had narrowed between whites and Hispanics, from 28.2 points to 26.5 points, pushing homeownership for Hispanics just slightly ahead of that for African Americans.

Others, however, are skeptical that 100-percent-LTV mortgages alone can close the gap in homeownership rates either between whites and minorities or between middle-income and lower-income earners. It will have an effect on some groups," says Eric Belsky, executive director of the Joint Center for Housing Studies at the John F. Kennedy School of Government at Harvard University, Cambridge, Massachusetts.

"I don't view this as how you get over the top. There's only so much mileage you can get out of making no down payment. You might add 1 percent to the national homeownership rate" with ambitious programs offering 100-percent-LTV loan products, says Belsky.

Belsky sees important benefits from no-down-payment mortgages, however, for lower-income workers. "Clearly, they would benefit more from the product," he says, "but they have lower average credit scores," and might have difficulty qualifying for these loans.

Fannie and Freddie offer 100-percent-LTC products

Both Fannie Mae and Freddie Mac have introduced 100-percent-LTV mortgages. Freddie Mac was first with a product introduced in the fall of 2000. Fannie Mae's product, the Flexible 100[SM] mortgage, was introduced in early 2001. While Fannie's loan is offered to any borrower who has little savings, "it is designed to expand the market for homeowners," says Liz Bayliss, director of product development in the single-family business at Fannie Mae.

She explains: "Many good [borrowers]' have good credit and a stable income. The only thing they don't have is the down payment. Now, they will be eligible for a mortgage loan."

Underwriting for Fannie Mae's Flexible 100 is done by Desktop Underwriter[R], which does not require a numerical credit score. Bayliss says there is no limit on how many loans can be done by mortgage lenders using this product. "This is a full-blown product," not an experiment, she says. Since the program began, 35,000 households have been able to purchase a home through Flexible 100, according to Bayliss.

To a great extent, Fannie Mae's adoption of the Flexible 100 came on the heels of its success with the Flexible [] mortgage, which is a 97-percent-LTV product introduced in 1998. Since Flexible 97 was introduced, Fannie Mae has funded 80,000 loans under either the Flexible 97 or the Flexible 100, Bayliss says. Fannie Mae did not share data on the performance of its loans by product category, and it is too soon to have data on the Flexible 100. High-LTV products as a group have performed "as expected," says a Fannie Mae source.

The underwriting guidelines for Fannie Mae's Flexible 100 allow the borrower to obtain funds from third parties, including gifts, grants and unsecured loans from relatives, employers, public agencies and nonprofit organizations.

Freddie Mac reports its volume has been modest since the introduction of the Freddie Mac 100 Mortgage. Douglas Robinson, Freddie Mac's director of corporate communications, says, "The volume has not been significant at all." He adds, "It hasn't caught on."

The corporation envisions the limited market for the Freddie Mac 100 Mortgage as higher-income homebuyers who want to place the funds they would have used for a down payment into other investments. The target market is, thus, for buyers of "moderate to more-expensive homes who don't want to pull their money out of the market" for a down payment on a new home, Robinson says. Although the stock market had peaked in the spring of 2000, there was still expectation that homebuyers could earn a better return in the financial markets than they would get by putting their money into a home, Douglas explains.

The biggest player in high-LTV lending outside the VA has traditionally been the FHA. As recently as 1998, one-third of the FHA's business was in 100-percent- to 102-percent-LTV loans, according to Andy May, vice president of product development and marketing at United Guaranty. Indeed, FHA's lending volume has not kept pace with the enormous growth in the market that has occurred since 1998. Endorsements, which are loans that the FRA has decided to approve and insure, stood at 1,091,289 for the fiscal year ending Sept. 30, 1998. They rose to 1,219, 269 in 1999 and then fell a sharp 25 percent to 921,283 in 2000. In 2001 the number of FHA endorsements rose almost 16 percent, to 1,066,883.

United Guaranty pioneers new high-LTV products

The private sector, in the meantime, has moved in to lead the way in the area of high-LTV product innovation. That's also the view of United Guaranty's May. "FHA was the granddaddy of high-LTV. They did 100 percent of the business," he says. "Their number has been dropping as our number is taking off," May says.

By May's calculation, the 2001 volume of 100-percent-LTV lending (excluding VA) is roughly $22.4 billion. This includes FHA's 100-percent-and-greater-LTV business of about $12.4 billion, May estimates. This represents only about 9.5 percent of the total insured product at FHA in 2001, a big drop from 33 percent in 1998, he says.

There was another $10 billion of business in the conventional market from lenders who offer 100-percent-LTV-andabove loans, as well as piggyback loans, with an 80-percent-LTV primary loan and a 20-percent-LTV purchase-money loan. In addition, the VA backed $35.1 billion in lending to 252,000 borrowers last year, and 90 percent of them received 100-percent-LTV loans, according to Keith Pedigo, director of the loan guaranty service at the VA. That would put the VA's 100-percent-LTV lending at about $28.4 billion and bring the total market of 100-percent-LTV-and-above lending to $50.8 billion.

Not unexpectedly, FHA views the size of the marketplace somewhat differently. For one thing, the FHA does not finance 100 percent of the principal, although loans can rise to 100 percent and greater when the upfront mortgage insurance premium is financed as part of the loan. If one adds the 1.5 percent upfront mortgage insurance premium into the loan, then the total LTV can rise to anywhere from 98.5 percent to 99.5 percent. Until recently, the up Front premium was 2.25 percent, which would have pushed more of the FHA's business into the 100-percent-LTV category if the premium is financed. FHA no longer allows any of the closing costs to be financed.

Finally, while some in the private sector see the 97-percent-LTV and 100-percent-LTV market as a growth market, FHA is more cautious. In response to a question asking if FHA thinks the market for 97-percent-LTV products can be increased, FHA replied: "This is difficult to determine, based on current market and economic conditions." Even so, FHA reports that 97-percent-LTV and 98-percent-LTV mortgages represented 50.8 percent of its total market for 30-year, fixed-rate mortgages in fiscal year 2000.

United Guaranty decided in 1997 to "go after the higher-credit-quality borrowers who know how to manage their money," says May. Toward that end, the company introduced a 100-percent- to 103-percent-LTV loan called Borrower Advantage[R]. United Guaranty then took its idea to Fannie Mae and Freddie Mac, but in both cases "they said it was too risky for them," according to May.

So United Guaranty started a conduit group--Centre Capital Group Inc., Walnut Creek, California, a wholly owned subsidiary of United Guaranty-structured to purchase the mortgage-insured products, and began to sign up lenders to offer the new 100-percent-LTV mortgages. The first loans were purchased in 1999 with 35 percent to 40 percent of the loan insured by United Guaranty. Since then, 350 lenders have participated in this program and closed loans to 25,000 homebuyers, May says.

Borrower Advantage typically requires a minimum FICO score of 700. United Guaranty also sets limits on the debt-to-income ratios. The combined debt-to-income ratio cannot rise higher than 38 percent. United Guaranty is adamant about not raising the debt ratios any higher than 38 percent on the back end after trying a pilot program in which it insured $100 million in loans with higher ratios (41 percent on the back end) and lower FICO scores (in the mid-600s). "We found the performance wasn't there, primarily because you're getting into the subprime world," May says.

United Guaranty has stuck with its high-quality-credit approach to 100-percent-LTV lending, but this does not mean the product is limited to high-income borrowers only. "You can be a fireman and a teacher and know how to manage your finances" and qualify for such loans, May says.

The securities backing these loans have been triple A-rated, and they have been quickly snapped up by investors--so much so that a qualified borrower might actually get a lower mortgage rate through this program than if he or she put down a large down payment. May cites as an example a couple that would have qualified for Borrower Advantage but instead chose to go the conventional route. In this case, they borrowed $375,000 and put down 25 percent and had a coupon rate of 71/8 percent. If they had kept their down payment and financed everything in the company's special 100-percent-and-higher-LTV program, the coupon rate would have been 7 percent, May says.

In the first year of its program, United Guaranty issued more than $1 billion in insurance. At that volume, "it hit the radar screen at Fannie and Freddie," May says. Both, as noted earlier, came out with their own high-LTV products in 2000 and 2001.

Can 100 percent LTV become a dominant product?

United Guaranty has surveyed mortgage products around the world and has concluded that the 100-percent-LTV mortgage has the potential to become a dominant mortgage product, not just a niche market. In the Netherlands, for example, the majority of mortgages are already 100-percent-plus-LTV. Often with these mortgages, the down payment is set aside as an investment, which is sometimes managed by an affiliate of the mortgage lender. "I think it can happen handsomely in the United States," says May, meaning he sees this as a potentially big market.

While declining to say which lenders are involved, May says that one FDIC-regulated (Federal Deposit Insurance Corporation) mortgage lender is already offering such a product, named Borrower Advantage Plus[SM] And others are interested.

One mortgage lender that is very interested in this product is ABN AMRO Mortgage Group Inc., Ann Arbor, Michigan, which is owned by a Dutch bank, ABN AMRO Bank N.V., Amsterdam. The 100-percent-LTV "saving mortgage" captures about 60 percent of the Dutch mortgage market, according to Klass van der Velde, senior vice president at ABN AMRO, Amsterdam. The appeal of the 100-percent-LTV mortgage, he explains, is its "double-tax advantage." Both the mortgage payment and the earnings on the investments associated with this mortgage are tax-deductible. When a borrower pays down a mortgage, the portion of the payment that would have gone to pay down the principal is, instead, directed into an insurance product or investment account, according to van der Velde. Thus, even the contribution into the investment is tax-deductible--and so are the earnings it accumulates. "As long as you don't touch the life insurance for 12 years," then there is no tax, van der Velde says.

The saving mortgage has been available in the Netherlands for more than 15 years, and the lenders that offer them report very low delinquencies and defaults. Property values have not been an issue since home prices have been rising at about 10 percent a year for several years, so properties quickly develop equity in them, says van der Velde.

ABN AMRO is looking into the possibility of offering products like the saving mortgage around the world, including the United States, says Rutger van Faassen, global mortgage associate at ABN AMRO, Amsterdam. The appeal of such a product outside the Netherlands might not be as great as within, since the Netherlands may have a "unique tax situation" that makes the product very popular, says van Faassen.

Wells Fargo's Easy-to-Own, No Money Down mortgage

Des Moines, Iowa--based Wells Fargo Home Mortgage Inc. may have come up with one of the most flexible loan products yet in the emerging market for 100-percent-LTV mortgages. It has a catchy name, too--the Easy-To-Own, No Money [Down.sup.SM] mortgage (ETO/NMD). This 30-year, fixed-rate portfolio loan allows a third party, such as a local municipality or nonprofit organization, to pay part or all of the closing costs, according to Andre Brooks, vice president of emerging markets at Wells Fargo in Silver Spring, Maryland. Or, Wells Fargo will finance a portion of closing costs up to 3 percent of the value of the loan. Wells Fargo will even go to a 45 percent debt-to-equity ratio to qualify borrowers.

As for the borrower's credit rating, Wells Fargo is "looking at each credit profile individually," says Brooks. "There is no defined bright line, like a FICO score," he adds. Instead, Wells Fargo is using its accumulated expertise in evaluating nontraditional credits, such as looking at the culture of borrowers, for example, and their payment histories for rent and utilities.

The ETO/NMD mortgage was pioneered last year in five markets--Washington, D.C., Los Angeles, Dallas, Philadelphia and Phoenix--and is being expanded into 31 markets across the nation, according to Brooks. "We are comfortable with the credit risk of the product. It is an important product solution to the needs we have identified, and it makes a lot of sense for the corporation, too," he says. Wells Fargo believes this new product will expand the potential population for homeownership and not just transfer the potential population from one product segment to another.

Wells Fargo has a strong commitment to expanding the portion of its mortgage business that can be classified as affordable lending, Brooks says. The volume of affordable lending at Wells Fargo rose from 20.7 percent in 1998 to 24.1 percent in 2000. (This is lending to borrowers whose income is 80 percent or less of the area median.) One of the reasons, he explains, is that "we fundamentally believe that the low- to moderate-income, minority consumer represents the growth engine of the future" for the mortgage banking industry. Wells Fargo is driven in its innovation by, among other things, high housing prices in some markets, such as California, where Wells is a big lender.

Wells Fargo is also dedicated to preserving homeownership for low- and moderate-income borrowers, Brooks says. The lender adopted a Home Equity Loss Protection (HELP) program to "respond to concerns that consumers were becoming victims of predatory lending," Brooks says. These 97-percent-LTV refinance mortgages are being made available in eight urban markets. The loan is targeted to homeowners who may have been victimized by predatory lenders that lent money at exorbitant interest rates for home renovation.

HELP was undertaken in conjunction with the Neighborhood Reinvestment Corporation (NRC), Washington, D.C., and Freddie Mac. NRC has affiliates all around the nation dedicated to counseling potential homeowners before they buy their home and counseling them afterward to help them keep their homes, according to Steven Tuminaro, director of external affairs at NRC. Freddie Mac has earmarked $20 million in loans for this program.

Indeed, Tuminaro says, the market for 100-percent-LTV lending would have "vastly expanded" if it were not for the damage done by predatory lenders, who refinance mortgages, sometimes with cash-out, but charge rates as high as 12 percent to 14 percent. Many of these homeowners eventually default, the property is flipped, and then it is sold to another low-income buyer who might be a prime target for one of the predatory loans, Tuminaro says. These defaults, however, cloud the image of high-LTV lending and encourage some investors and lenders to steer away from it, he says. The HELP loan is available in nine cities: Boston; Chicago; Cleveland; Los Angeles; Sacramento, California; New York; Syracuse, New York; Oklahoma City; and Rutland West, Vermont.

What can one make of all the product innovation? For one thing, the FHA without further innovation could risk being left behind in the high-LTV market, which it once dominated. Further, Fannie Mae, Freddie Mac and the private sector will continue pushing the frontiers of product innovation.

Their efforts may well expand the universe of homebuyers and help more minorities and immigrants become homeowners. This innovation, too, can provide more sophisticated investors with a whole new array of products to suit their financial goals and investment needs.

Robert Stowe England is a freelance writer based in Arlington, Virginia.
Figure 1

Portions of the Market Represented by High-LTV Mortgages (*)

% Composition of High-LTV Market September 1998 September 1999

80.01%-90% 12.83 12.20
90.01%-95% 8.71 8.47
95.01%-100% 6.17 7.74
100.01%-105% 2.33 2.62
High-LTV=80.01%-105% 30.04 31.03

% Composition of High-LTV Market September 2000 September 2001

80.01%-90% 12.26 12.10
90.01%-95% 9.00 8.85
95.01%-100% 8.71 8.71
100.01%-105% 2.54 2.36
High-LTV=80.01%-105% 32.51 32.02

% Composition of High-LTV Market Change, 1998-2001

80.01%-90% -0.73
90.01%-95% 0.14
95.01%-100% 2.54
100.01%-105% 0.03
High-LTV=80.01%-105% 1.98

(*)MBA prime market

Note: Percent composition based on number of loans


RELATED ARTICLE: VA's Good Track Record on 100-Percent-LTV Lending

TRADITIONALLY, THE HIGH-LTV (LOAN-to-value) market has been dominated by the Department of Veterans Affairs (VA) and the Federal Housing Administration (FHA). The VA has provided 100-percent-LTV loans to eligible veterans since 1944, and today 90 percent of the VA's loan volume is in l00-percent-LTV mortgages, according to Keith Pedigo, director of the VA's loan guaranty service. In fiscal year 2001, which ended Sept. 30, 200l, the VA guaranteed 252,000 loans with a total face value of $31.5 billion.

Few would disagree with the proposition that the VA has demonstrated over time that 100-percent-LTV mortgages are a viable and sustainable market, at least when it is backed by government support. The VA program was designed from the beginning to be a money-losing operation, according to Pedigo. (The FHA, by contrast, was designed to be self-supporting.)

The VA's guarantee generally backs between 28 percent to 29 percent of each loan made by lenders in its program. Lenders, then, are liable for the remaining 71 percent to 72 percent, Pedigo says. However, for smaller loans, the guarantee can be higher than 29 percent. For loans of less than $45,000, for example, the VA offers a guarantee of 50 percent of the loan. Thus, while the lender has some risk of loss with VA loans, "in most cases there is no loss suffered" when there is a default, says Pedigo.

The volume of VA lending has declined since its recent high in 1999 of $56 billion and 485,000 loans. In 2000, it fell to $24 billion and 200,000 loans. Fiscal year 2002 (which began Oct. 1, 2001), however, is running ahead of pace in 2001. While the VA's overall delinquency rate rose in the third quarter of 2001 to 8.11 percent, it is substantially below the FHA's 11.56 percent. Why the better performance? According to Pedigo, it's VA's constant monitoring of the underwriting process to be sure that lenders are following it strictly. "We delegate to them the authority to underwrite loans, but insist they follow the VA credit guidelines," he says. The VA periodically takes a sample of 10 percent of the loans and reviews their underwriting. Also, the VA's nine regional offices contact veterans to "see if we can help bring the loan current" after the payment falls behind 90 days. "Sometimes we intervene with the lender to reschedule the loan," says Pedigo. This intervention prevents a lot of seriously delinquent loans from going to foreclosure, he says.

The performance of the VA mortgage lending program has benefited from the discipline gained by borrowers in military service, Pedigo says. This discipline transfers into financial matters, too, he says. The VA allows lenders to use various credit-scoring systems, but credit scoring is not required. The VA has traditionally used what it calls the "residual income approach" to qualify buyers. This process begins with the veteran's gross income and subtracts all expenses to compute how much money is available for family support. This is then compared with numbers from the Bureau of Labor Statistics about how much it costs to live in the veteran's immediate geographic area. This approach then looks at the total debt-to-income ratio to determine if the veteran can handle the mortgage and meet basic needs. If debt-to-income exceeds 41 percent, lenders are asked to provide "significant justification for making the loan," Pedigo says. The justification could be that the residual income is good or that the borrower ha s significant savings.

The VA charges a 2 percent fee on each loan for first-time users of the program (and 3 percent for subsequent loans with VA) to partially offset the cost of program operation. The program is additionally supported by appropriations that typically range from $300 million to $350 million a year, Pedigo says.
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Author:England, Robert Stowe
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Date:Feb 1, 2002
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