How do you create mortgage market success?

One government agency lends to people who have higher debt-to-income ratios, lower down payments, and more spotty credit—and has held delinquency rates below national averages even as its lending volume has surged to more than six times the level it stood at just before the financial crisis.

This improbable success story has caught the attention of housing industry analysts. It seems like the kind of model every lender should try to emulate. But it may be hard for others to replicate the success of the Veterans Affairs home lending program.

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The VA’s program is available to anyone who has served, as long as he or she was not dishonorably discharged. It can be used to buy a home or refinance a mortgage. VA mortgages require no down payment and no mortgage insurance for smaller down payments, and many borrowers also take advantage of its closing cost assistance.

Take-up of VA loans has surged since the housing crisis. In 2015, the agency lent $ 155.6 billion worth of mortgages—compared with $ 39 billion in 2008. That’s in large part because the VA is now filling the role that subprime and Alt-A lenders did before the crisis, according to John Bell, assistant director of loan policy and valuation for the VA.

But VA aims to do much better for its borrowers than those lenders, most of whom were swept away in the wake of the crisis.

Read also: Homeownership is at an all-time low—and good luck getting a mortgage

While the agency does consider credit scores as one component of a borrower’s profile, they aren’t as important as they are in other mortgage programs, in part because many veterans have much less robust credit histories than most civilians.

The VA relies on an underwriting tool they call “residual income,” which Bell calls the agency’s “secret sauce.” Residual income takes into consideration how much money homeowners will have after the mortgage and all regular expenses, and even unexpected one-time occurrences, are paid for.

It doesn’t just help supplement the traditional metrics found in most credit profiles, but also provides a more holistic look at a borrower’s ability to pay, Bell said. VA prizes sustainable homeownership, he told MarketWatch, and wants to make sure that once a veteran closes on a home purchase, he or she will be able to afford it in the years to come.


Modern is often used interchangeably with contemporary to describe home styles. Generally speaking, modern homes have simple lines, while contemporary homes include more pops of color. Photo: Joshua Fletcher for The Wall Street Journal

The performance of VA mortgages is testimony to that mission, said Karan Kaul, a research analyst at the Urban Institute. It shows that individual metrics that most lenders emphasize, like a sizable down payment, may not be as important as the holistic view that the residual income analysis offers.

Residual income testing is “a very powerful tool and a good test of how the loan will perform,” Kaul told MarketWatch.

But Kaul thinks there may be another factor that makes it hard for other lenders to simply follow the VA’s example. “I have a sense that there’s a behavioral aspect of veterans, an element of military discipline,” he said. “They may take their mortgages more seriously than the general population and feel it’s more important to stay current.”

See: Mortgage delinquencies fall to lowest in at least 16 years

Despite that sentiment, there is one aspect to the explosion in VA lending that concerns Kaul. The VA only guarantees 25% of the loan amount, unlike the Federal Housing Administration, the other government agency most likely to buy mortgages made to people with spotty credit and low down payments. FHA guarantees 100% of the loan.

The “nonbank” lenders that now dominate the mortgage market have never been tested in a severe downturn, Kaul pointed out. Since nonbanks don’t have to retain as much capital as banks do, it’s not clear whether weaker lenders would be able to absorb 75% of the losses from a rash of foreclosures, Kaul said. Still, the exceptional performance of the VA mortgages during the last recession signals that may not be a major concern.

John Bell is a veteran himself. He served four years in the Navy and has been working in the mortgage market ever since he graduated college, including briefly as a lender of VA mortgages. He’s also on his fifth VA mortgage.

Bell is proud of the work the agency does helping veterans become homeowners, helping military spouses and families get into homes, helping adapt homes to the unique needs of those who’ve been injured in combat, and much more. He also says he’s driven to ensure the VA is a viable program “10-15 years from now. We want to make this successful without sacrificing compliance and sustainability.”

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