Appraisals and ValuationsMortgage

Why VA mortgage loans go to the bottom of the stack

Even with government guarantee, borrowers face headwinds

HW+ VA lending - couple buying home

It’s been rejection after rejection for Isabel Williams’ client, a military veteran in Port St. Lucie, Florida. Since the client began the search for her dream home earlier this year, her Veterans Affairs mortgage loan-backed offers have been rejected over a dozen times.

Williams, the broker-owner of We Save Loans, said her client has all but given up on buying an existing home with VA financing. Instead, she is looking to buy a newly constructed home from a large homebuilder.

Homebuilders, Williams said, are more concerned with the overall investment, and don’t have the same prejudices toward and misconceptions about VA financing that individuals do.

But it might be a while until Williams’ client could actually stop paying rent and move into a home. If she is unable to wait the six months or more it could take to finish construction, she may forgo her hard-earned government benefit altogether.

“She may have to change from VA to conventional to be more attuned to the current market,” Williams said. “When people are deciding which offer to accept, the pecking order is cash, conventional, FHA and then VA.”

For loan originators who represent VA borrowers, the aversion to VA deals is confounding. From a risk-profile perspective, in addition to the government guarantee that veteran borrowers command, VA borrowers have much lower default rates than FHA loans, another government-backed loan.

The VA mortgage loan allows veterans to pay little or no down payment without a mortgage insurance premium. The financing also caps the amount in origination fees that lenders can charge veterans. To incentivize private lenders who issue the loans, the government guarantees that the loan will be repaid even in case of default. The government guarantee and lower-risk borrower profile make the loan attractive for lenders and investors in securities backed by VA mortgage loans.

But for borrowers to receive a loan with such attractive terms, they must first make it to closing. In the current market, with even conventional borrowers taking extraordinary measures to distinguish themselves from the competition, VA-financed offers are falling to the bottom of the stack.

Brad Dragoo, a branch manager at Fairway Independent Mortgage Corporation, said he has never seen the situation more dire for veterans.

“The reason we would do a VA loan is because it’s better; it’s a benefit they’ve earned,” said Dragoo. “Then they find out none of the sellers are accepting them.”

Bad subprime memories

Sellers are not required to accept any offer, including one with VA financing.

The privilege gives sellers discretion to choose the strongest offer, but it can place VA borrowers at a disadvantage, since the VA financing process is perceived as cumbersome.

“They’re locked out right now,” said Sam Elder, a mortgage consultant at First United Bank. “It’s the listing agent’s responsibility to recommend offers to their client and so the listing agent is putting themselves out there. They have nothing to gain by suggesting an inferior offer.”

Some of the negative perceptions of VA financing is based in reality: there are additional inspection requirements, and a VA appraisal differs slightly from a conventional one.

Mostly, explained Sametrius Ruben, who represents VA borrowers, the offers fail because listing agents advise their clients the VA process will be more trouble than it’s worth. She described the dynamic as discriminatory, although sellers are not breaking any law by turning down VA offers.

“It can be discriminatory,” Ruben said, especially when sellers learn that the prospective buyer is not putting any money down.

“I wish the only thing the seller could see is the offer amount and the terms,” said Ruben. “When they get into the financing end of things, it hurts both FHA and VA borrowers.”

Some listings agents associate the low down payment with the terms offered to subprime borrowers in the years before the great financial crisis. That association is particularly prevalent with agents who were selling homes during those years, said Ryan Leahy, sales manager at Mortgage Network.

“Agents get a pre-acceptance letter that says ‘$500,000 with no money down’ and their mind goes back to the subprime lending years,” said Leahy. “All they see is ‘no money down,’ when really, it’s a government-backed loan.”

Under contract! Now what?

After an offer is accepted, borrowers must complete an appraisal.

The appraisals are administered by the VA — rather than a private company or an in-house appraiser.

Otherwise, the process is very similar to conventional appraisals, despite a reputation for being nightmarish. The added layer of removal can be a headache if there are delays or snags, since lenders have little ability to hold a VA appraiser accountable.

Appraisals rely on past comparable transactions, which makes it a challenge to capture with the rapidly increasing values and historically low inventory. If the appraiser finds the value to be much lower than the agreed-upon price, the borrower must then make up the difference, but not all veterans are able to do so.

“The concern is that if you have a no-money-down VA loan and the value appraises short of what you’re willing to pay for the home, that can cause the whole deal to go south,” said Leahy.

Many homebuyers are putting clauses into their offers assuring the sellers they will still buy the home if it is under-appraised by a specific amount. Homebuyers with a limited amount for the down payment don’t have the luxury of including those clauses, “which are obviously interesting to the seller,” said Leahy.

There is some variation in appraisals. If a VA-appraised value comes in much lower than expected, it’s possible to challenge the value. Unlike with conventional appraisals, however, the process goes through the VA.

“In terms of a rebuttal, it’s more complicated, and it’s less likely we’ll have a successful rebuttal,” said Elder.

Whose benefit

VA mortgage loans are intended to serve as a reward to veterans for serving their country. But the government’s guarantee to pay the loan in case of a default also makes it an attractive product for lenders.

Lenders sell the mortgages on the secondary market via Ginnie Mae, a government-owned corporation and primary securitizer of VA loans.

VA-insured loans make up the largest share of Ginnie Mae’s mortgage-backed securities, at 43%. Nearly all — more than 99% — of VA-insured loans are pooled into Ginnie Mae securities.

Unlike Fannie Mae and Freddie Mac, whose securities only have the implicit, or “effective” backing of the U.S. government, Ginnie Mae securities have the “full faith and credit” guarantee of the federal government.

That ironclad guarantee, both at the individual loan level and the bond security level, makes Ginnie Mae bonds particularly safe for investors.

“From an investor perspective, the guarantee is really attractive,” said John Levonick, CEO of Canopy. “In the event that the VA borrower doesn’t make a payment, given that the loan has the VA guarantee, the government will continue to pay the bond for that loan.”

But even before individual loans are sold on the secondary market, there are ways lenders pass on costs to borrowers.

According to the terms of the VA financing, lenders cannot charge more than 1% in origination fees. To get around that requirement, lenders often change the label of the fee — to call it a discount fee.

“They’re able to change verbiage on their fees, so the rule doesn’t apply,” said Williams. In one case she described, it amounted to $4,000 in fees on a loan.

With conventional mortgages, faced with a high-cost loan, a borrower might go to one of many available lenders. But the higher-cost models in VA financing depend on the product occupying a proportionally small part of the market.

“VA financing is more niche, and so there is less competition,” said Christopher Griffith, who co-leads the VettedVA referral service, which verifies information for veteran consumers.

A study published in November 2020 by referral service Own Up found that lenders typically require a 67% larger profit than they do on conventional loans. Its analysis estimated the cost in excess interest to a borrower with a $254,000 mortgage amounted to $13,000.

“These are very veteran-specific facing companies,” said Williams. “The perception is that these companies are going to take the best care of you – and you don’t question whether it’s the best interest rate or not. That assumption costs [veterans] a lot of money.”

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