Protecting Veterans from Proposed Legislation That Will Do More Harm Than Good
On January 11, 2018, U.S. Senators Thom Tillis (R-NC) and Elizabeth Warren (D-MA) introduced bipartisan legislation in an attempt to protect veterans from predatory lending practices regarding VA refinance loans.
As I have mentioned in prior articles, I have a strong fear that when government steps in and tries to regulate the private mortgage sector, it could lead to overreaching. In turn, overreaching legislation could end up hurting the veterans it was initially meant to protect.
While the legislation from Senators Tillis and Warren is still just a proposal, if it's carried out as currently described, I strongly believe that it will lead to an increase of suffering and real economic pain for veterans who own homes.
Benefits of the Current VA Home Loan Program
If you are not familiar with the VA home loan program, the easiest way to explain it is that it aims to make the dream of owning a home a reality for all eligible veterans.
Historically, because of the honorable military service of these amazing men and women, the VA home loan program has also been able to grant special benefits that are not available to civilians. Some of these benefits include:
- No money down on the purchase of a new home
- No monthly mortgage insurance for any VA loans, regardless of loan-to-value ratios
- The ability to lower the rate with the VA IRRRL
- Lower credit standards
- Looser debt-to-income requirements
- Lower rates
- Certain non-allowable fees that can be charged to others but not veterans
A Quick Summary of Loan Churning
As I've recently discussed in my articles on mortgage churning and Ginnie Mae's 2017 APM, Senator Warren began questioning whether or not veterans were capable of making their own educated decisions on when it made sense to refinance and when it did not make sense.
Together with a handful of industry professionals, Senator Warren has decided that loan churning is the single largest issue facing the VA home loan space.
Loan churning occurs when a home is repeatedly refinanced with very little benefit to the borrower. Also, there is often a strong disregard for closing costs and how they will affect the borrower's finances.
It's also important to note that loan churning is not something that only takes place with veterans–it can happen with all loan types and kinds of borrowers.
Protecting Our Veterans
I completely agree that our nation's veterans deserve protection from aggressive lenders. I even agree that something needs to be done to ensure this protection. If you've read my prior articles, it's clear that I've always believed this.
However, I do not think that villainizing the VA streamline loan is the correct approach. As I've said in the past, making the VA streamline loan more difficult to obtain could hurt veterans by locking them into higher loan rates for a longer period of time. Similar legislation that was passed in February 2017 shows that this can—and will—happen.
Should Senator Tillis & Senator Warren's changes be implemented as is, thousands of veterans each month will be hurt and no longer helped by a program that has always afforded them special benefits not readily available to anyone else.
An Overview of the Proposed Changes
The senators' proposed changes to the VA program—which would most likely affect just the VA IRRRL—are as follows:
- The fees associated with the VA streamline must be recouped within 36 months
- The interest rate if fixed on the new loan must be .5% lower than the existing rate being refinanced; if the new loan is an adjustable rate loan (ARM), then the new rate on the ARM must be 2% lower than the current rate being refinanced
- The loan being refinanced must have made a full 6 payments before it can be eligible for a VA refinance loan
Potential Problems with the Proposed Changes
Though these changes may not seem too strict at first glance, for someone like myself that sees what our veterans need on a daily basis, I can assure you they are!
These changes have the potential to hurt our veterans in a variety of ways, which are outlined below.
Issues with Requiring Closing Costs to Be Recouped within 36 Months
Saving a veteran $100 – $200 a month by putting them in a VA streamline loan, even if we can't recoup the closing costs in three years, still offers them a lot of financial value. But under this rule, we would have to tell them no, and they’re stuck with the financial burden of paying extra money each month. If rates keep climbing, this military family would be stuck with that rate. In just four years, this situation could end up costing them an extra $4800 – $9,600!
At Low VA Rates, we have regular monthly experiences that serve as real evidence that the VA streamline loan prevents veterans from losing their homes or having to survive on credit card debt or payday loans. If the benefit of the VA IRRRL is taken away through legislation, many of our nation's veterans will suffer.
To illustrate my point, I've included below just one specific email we received from a veteran who felt that refinancing his home was a "saving grace" for his family:
Another reason why I find the 36 month requirement problematic is that there are readily available statistics showing that most homeowners in this country are only in their homes for about 3.5 – 5 years.
However, what if a veteran knows they are going to keep their house for longer and rates are at an all-time low (like they have been for the last few years)? Well, unless they can recoup the closing costs in 3 years, the government will prevent them from securing the lower rate.
Part of the problem is that the government, at least at first glance, has not defined what fees and costs are to be included in this recoup test. Because this is undefined, it could unfairly harm veterans depending on the state they live in and the time of year they refinance.
For example, the rule does not define if "closing costs" include the escrow funds for insurance or property taxes. In states like Texas and Florida where real estate taxes are much higher than average, a refinance that occurs before the property tax is paid out for the year would need to have thousands of additional dollars added to the escrow and deposited into the new loan. If these are then defined as being part of the "closing costs," it would be almost impossible to recoup them in just three years.
As another example, the rule doesn't address how things should be handled when a veteran decides to couple their refinance with a term decrease. Decreasing the term from a 30-year to a 15-year loan is one of the most amazing and advantageous ways for veterans to pay their mortgages off faster, but it would be difficult to recoup the upfront cost of making the switch in such a limited time frame.
Because of the lack of clarity regarding what would and would not count as closing costs, this rule could potentially kill the VA streamline loan in a way that is very similar to what has happened with FHA streamline loans. Do we really feel that veterans—those who have served this nation and given the ultimate sacrifice—should have the exact same benefits as everyone else? If so, where is the “benefit"?
Issues with the Required 2% Decrease for Refinancing to an ARM Loan
To start, I want to make it clear that we have no concerns with the .5% interest rate drop for the second recommended change. However, we do feel that there is a real issue with treating ARM loans differently.
At Low VA Rates, we are very proud supporters of the VA hybrid ARM. Not allowing lenders to offer it unless there is a full 2% drop in the interest rate is essentially lawmakers trying to quietly kill a very safe and beneficial program, especially when it is applied across the board to all VA ARM loans.
The VA has three types of hybrid ARM loans: one where rates are fixed for a three year term, one with rates fixed for a five year term, and one with rates fixed for a seven year term. I agree that the 2% reduction rule would be beneficial for the 3-1 hybrid ARM loan, but I am adamantly against requiring such a drop when going to a 5-1 or 7-1 ARM because of the negative impact it could have.
Here is an example of how this rule could negatively impact a veteran borrower:
A veteran has a 4.5% 30-year fixed rate loan of 250,000. Under these conditions, they would pay $1267.00 a month or $206,000 in interest over 30 years. In the first five years alone, they will have paid $52,000 in interest.
However, if the veteran were able to lower their rate to 2.75% on a 5-1 hybrid (a decrease which would not be allowed under the proposed rule because it only drops the interest rate 1.75%), they would only pay $32,000 in total interest. In this scenario, the monthly payment would also be $247 less each month!
In summary, the 2% rule in this specific scenario would prevent the veteran borrower from enjoying:
- $247 in savings on their monthly mortgage payment
- $20,000 in interest savings over the first 5 years
- And the freedom to choose
Issues with Seasoning the Loan for Six Required Payments
I've made my opinion about loan seasoning requirements pretty clear in my other posts. However, compared to the other two aspects of this proposed legislation, I actually find this one to be the least harmful.
Least harmful, though, is not the same as good.
Essentially, the seasoning requirement allows veterans to be held hostage by a higher rate for six months while the loan seasons. As I've said before, both in this this article and in my prior ones, history has already proven this will happen.
This rule is ripe for allowing lenders to put veterans into even higher rates. Because veterans won't be able to get out of a high rate for at least six months, lenders know they can make some extra money off them in that time, so of course they will take advantage of it.
Alternative Solutions to These Requirements
I recognize that there are a lot of valid concerns being brought up in regards to protecting our veterans from predatory lending practices. Though I've poked a lot of holes in this proposed legislation, I also want to offer alternative solutions that will work.
A Better Requirement for Recouping Closing Costs
Instead of only allowing 36 months for the loan to recoup the closing costs, I propose a break even that allows for 60 – 85 months. I would also urge that either the regulators, the VA, or Ginnie Mae clearly define what fees would be included in the recoup or net tangible benefit test (NTB).
My recommendation would be to not include what the mortgage industry calls prepaid items. If these were included, it would be very harmful and impact certain borrowers more than others (like those in states where real estate taxes or the cost to insure a home is much higher). The impact could even be significant enough that it could go against certain fair lending regulations.
A much more educated approach to the closing cost recoup test would be to make sure that it doesn't include prepaid interest, the VA funding fee, and certain prepaid escrow funds. At Low VA Rates, we feel our veterans are smart enough to make their own decisions on closing costs, especially because not every veteran family has the same needs.
So, what fees should be included? My personal recommendation is for:
- Origination and discount points
- All title & 3rd party fees (credit report, flood cert., attorney fees, etc.)
And, though I've already discussed some of these, I feel that it's worth repeating the fees I don't think should be included:
- VA funding fee
- State fees
- Recording fees, etc.
Finally, I would also recommend that no impounds or escrow fees should be included. Or, if they are, we would mandate that the VA force the original lender to roll the existing impound account over into the new loan.
Apply the .5% Reduction Rule to All Loan Types
Instead of having a different interest rate drop requirement for ARM loans, the .5% reduction in rate requirement should be applied universally, regardless of whether the loan is an ARM or a fixed rate loan.
The VA hybrid ARM loan is safe, secure, and has allowed those that fight for our freedoms to make the choice as to where to put their hard-earned money each month. I myself have a 7-1 hybrid conventional ARM loan on my primary residence, and many other types of loans are generally adjustable, including student loans, credit card rates, and most home equity lines of credit.
So, if they're generally safe, why do ARM loans get such a bad rap? Unfortunately, ARM loans have received a lot of negative press in the wake of the great recession caused by the housing collapse, but this reputation is mostly unfounded. At Low VA Rates, we know it was not the VA hybrid ARM loan that caused this collapse. It was actually the stated income loans and loans that allowed for negative amortization or interest-only payments.
Allow Veterans to Refinance When It Makes Sense
Instead of setting an arbitrary amount of time that a loan has to season, we should allow a veteran to refinance as soon as it makes sense, regardless of how many payments they've made.
It's as simple and as easy as that.
But, to go just a bit further to clarify what I mean, I believe that the single easiest way to fix the related issues of loan churn and putting veterans into risky mortgages would be to require an appraisal on every VA IRRRL.
I would also recommend that lenders be required to pay for the appraisal, as this would discourage the few bad lenders from churning VA streamline loans since they would be fronting part of the cost in the form of the appraisal. In addition, having this requirement would also let veterans know their home's value, and this knowledge would help keep them from getting upside-down on their mortgage.
And, it would make loan churning a thing of the past.
What the Future Holds for the VA Loan Program
Only time will tell how the general public, other lawmakers, and the industry will react to these proposed changes. However, in my opinion, changing the VA home loan program, especially when it has never needed a taxpayer bailout, is a travesty.
Early on in my professional career, I learned the truth of the old maxim, “if it ain’t broke, don’t fix it.” While I believe this is true of the VA home loan program, I realize not everyone agrees, and the underlying debate is about whether the program is broken or not.
While this debate continues to happen, we need to make sure that everyone involved is coming from the right place. For example, a lot of the discussion and proposed legislation have been based on the concerns of bondholders. However, their interests don't always align with the interests of our veterans, simply because their only motivation is to get a better return on their bond investments. So instead of being concerned with their needs, everyone involved in this debate should focus on the needs of our veterans.
In addition, we should all also be considering the historical facts that serve as answers to the following questions:
- Are VA foreclosures higher or lower than FHA, Conventional or USDA?
- Has the federal government taken on more losses on VA loans or FHA?
- How much did the government initially lose on the bailout of Fannie Mae and Freddie Mac? (Hint: The answer is $124,000,000,000.00.)
If you know the answer to these questions, it seems strange that, somehow, it's the VA loan program that needs to be fixed. Hopefully, before it's too late, we're able to stop harmful legislation that hurts our veterans instead of helping them.