By Chris Birk
Nearing its 70th anniversary, the VA loan guaranty program and its benefits -- no down payment, no private mortgage insurance and seller-paid closing costs -- have emerged as a lifeline for veterans and military families during a time of tight credit.
Military borrowers have increasingly flocked to these government-backed loans over the last five years. VA loan volume has soared nearly 170 percent since 2007, a clear and swift response to tougher lending requirements instituted after the housing bubble burst.
Furthermore, these loans continue to exhibit the lowest rate of foreclosure of any loan product, including prime loans. That's due in large part to the VA's prudent underwriting standards and its commitment to helping veterans on the edge retain their homes.
To be sure, VA loans aren't the best fit for every military borrower. Veterans with sterling credit and enough cash to cover a healthy down payment might want to seek conventional financing. But that's far from the norm for most service members and their families.
Military members can face a host of unique financial challenges. Credit card bills, savings accounts and more can fall by the wayside during a deployment abroad. Service members are more likely to be financially overleveraged than civilians, and they're often ripe targets for predatory lenders and other scammers. That can put veterans and active military in a tough spot when the time comes to apply for a home loan.
Lenders have rolled out stricter standards in the wake of the subprime mortgage meltdown, covering everything from credit scores and income to employment verification. The average credit score on a mortgage backed by Freddie Mac in 2007 was 704. In the first quarter of 2012, it was 758.
Credit scores in the mid-to-upper 700s can be hard to come by for those who have served our country.
Enter the VA home loan.
Congress created this guaranty program to help level the playing field and extend homeownership opportunities to soldiers returning from World War II. Since 1944, it has helped more than 18 million service members become homeowners.
The VA doesn't actually provide home financing. Instead, it basically insures a quarter of the mortgage, a layer of protection that gives agency-approved lenders the confidence to not just lend to veterans but to also offer interest rates consistently lower than conventional rates.
While there are no credit minimums or income requirements in the VA program, it's the lenders who can, and almost always do, introduce their own requirements that go beyond what the VA mandates. That said, qualified borrowers can purchase a home without a down payment, and the VA limits what they can pay in closing costs and lender fees. In the current buyer's market, seller-paid closing costs mean some veterans can buy a home and not spend a dime up front.
VA loans also feature more forgiving debt-to-income ratios than other loan programs. By the book, this ratio of monthly debt to monthly income shouldn't exceed 41 percent. But lenders have the flexibility to work well above that threshold provided the borrower clears additional financial hurdles.
To that effect, rather than be a "satisfactory credit risk," as the VA puts it, lenders want borrowers who can hit a specific credit benchmark; right now it's a score of at least 620. Veterans with a credit score below that mark will struggle to secure financing.
The program also utilizes a unique lending requirement that's helped make VA loans the safest on the marketin terms of foreclosure. Prospective borrowers need a minimum amount of "residual income" left over at the end of each month to cover everyday expenses. These levels vary depending on family size and geographic location.
For example, a family of four in Missouri must have at least $1,003 remaining after paying their mortgage and other major monthly expenses. Failing to meet these residual income requirements can jeopardize a veteran's loan file.
Safety and Sustainability
Years of lax underwriting and bad loans spurred the subprime crisis. Since then, there's been a lot of talk about the need for both banks borrowers to have "skin in the game," which typically means money on the line. For borrowers, that would come in the form of a sizable down payment -- at least 20 percent, if proposed mortgage changes take root.
The VA program flips the "skin in the game" notion on its head. Nearly 90 percent of VA purchase loans issued last year came with no down payment, yet these types of loans have the lowest rate of foreclosure. The VA puts a premium on responsible homeownership, and its unique residual income standard ensures borrowers have enough income to cover their mortgage payments and monthly household needs. Lenders are also incentivized to work with homeowners on modifications, repayment plans and other forms of foreclosure avoidance.
Given today's restrictive lending climate, that combination of flexibility and safety has made the VA program more vibrant and vital than ever. In fact, for the average military family, this long-cherished loan is often the simplest and sometimes sole path to homeownership.