A Ginnie Mae
official told Congress this week that his agency has growing concerns over the
incidence of “loan churning” in the VA mortgage program. Michel R. Bright, Ginnie Mae’s Executive Vice
President and COO was among four mortgage industry experts testifying about the
issue to the House Committee on Veterans Affairs on Wednesday. Bright said
since the loan churn problem became evident, Ginnie Mae has realized it could
ultimately harm borrowers in the form of higher interest rates and has the
potential to cause problems with investors that could spill over into FHA and
USDA loan programs as well.
Starting in early 2016, the agency and its
investors noted loan prepayment rates were increasing and serial refinancings
were occurring with greater frequency in the VA mortgages Ginnie Mae guarantees
and securitizes than in loans secured by other agencies. Some of the
prepayments were at speeds that could not be justified by economic
factors. Other alerts, especially a
weakening of Ginnie MBS prices versus other MBS, pointed to the growth of
anomalous refinancing behaviors.
Internal analysis, showed that some
lenders had apparently found an opportunity for quick profits by aggressively
pushing a series of loan refinances. There appear to be two underlying dynamics. There are an increasing number of veterans, and
many of them are susceptible to advertising schemes that appear to come from
reputable sources. Second, the Ginnie
Mae security trades at a premium price, typically $1.05 to the dollar. This incentivizes
lenders to pull loans from pools at “par,” (or $1.00 to the dollar) and deliver
them into a security at a premium, booking a 5 percent profit each time this
occurs. Ginnie Mae believe it is the
confluence of these factors that enable the loan churning.
It also appears that some lenders are
employing two patterns; one is to originate a loan substantially above
prevailing interest rates, i.e. a “premium loan.” These loans may include debt consolidation, or
are given to borrowers with very low credit scores, justifying in part the
higher rates. But Ginnie’s analysis found
that premium VA loans are also a business model, using aggressive marketing
tactics to push a higher rate than the borrower deserves; as proven by the
rapid refinance that occurs almost immediately thereafter. Lenders immediately
sell the loan into a Ginnie Mae MBS pool at a high price because of the high
interest rate, not only profiting up front, but creating a loan ripe for
another refinance into a lower rate.
Then that veteran begins almost
immediately to receive a constant stream of solicitations to refinance from
both the original lender and others, promising benefits like skipping a few
payments, a cash out refi, or lowering the rate with an adjustable
mortgage. Ginnie Mae sees borrowers who
are convinced to refinance multiple times in a year. These refis are usually
without tangible benefit to the borrower and often result in higher loan
balances as refinancing fees are buried or hidden in the new loan.
average cost of refinancing a VA fixed-rate refinance is $6,000, with an
average savings of $90 per month. This means the veteran will need 5.5 years to
recoup the loan costs.
The trend to higher interest rates is increasing
the push to refinance fixed rate products into adjustable ones. The average fee
for these refinances is $12,000, resulting in savings of $140, and requiring
seen years to break even, assuming the rate doesn’t adjust upward.
With rising home prices, some lenders now
specialize in cash-out refinances. While
there are benefits in some cases, Bright said, there are also some concerns. Ginnie
Mae sees loans where borrower credit characteristics appear to change
inexplicably from one month to another as well as the creation of a large group
of veterans who no longer have equity. In a worst case, they might need to
bring a check to the closing should they wish to sell.
Refinancing lenders are also offering to
refund tax and insurance escrows or lure veterans with offers to skip a payment
while the new loan is initiated get an escrow refund, and look at the monthly
payment sans escrow charges. This tactic can lead to larger mortgages, more
debt and the veteran paying a lot of money in fees for a riskier mortgage
without sufficient escrows.
Much of the
advertising directed at vets, Bright said, is inaccurate or misleading and some
have the appearance of being checks or official correspondence from government
The churning also
has implications for the broader mortgage market. The premium investors pay for Ginnie Mae
bonds directly translates into lower rates for VA borrowers and those from
other government loan programs. As loans
are refinanced, they are removed from MBS pools, taking away the return investors
expect as well as their incentive to price these bonds above par. This ultimately
increases interest rates. Because VA
loans are comingled in Ginnie Mae securities with other government programs,
FHA, USDA and other borrowers are paying the increased costs as well.
These challenges are not theoretical
Bright said. Ginnie Mae leadership recently
spoke with several large foreign institutional investors about their ongoing
Ginnie Mae MBS investments and every conversation related in part to concerns
about the VA loan churn issue and its impact on investments. If investors flee
the Ginnie Mae market, it could cause even higher borrowing cost for all
veterans and others in the coming years.
Ginnie Mae has already taken some steps to
eliminate churning. In 2016 it changed
rules on how soon after a refinance a streamline transaction of that same loan
can be pooled into an MBS. However, some lenders circumvented that rule by
originating other types of refinances. Last month that rule was expanded to
require a six-month seasoning before any type of refinancing.
Bright said there are three steps in a
long-term solution. First Ginnie must tighten its requirements. This year it will develop a firm definition
for premium loans and eliminate them from its securities. The VA must also establish
a framework to protect veterans from predatory lending practices. The third step. is continuous surveillance of
date collection and analysis to enforce adherence to the first two steps.
Also testifying before the committee were
Jeffrey London, Director of the VA’s Loan Guaranty Service; Dave Motley, Chairman of the Mortgage Bankers Association
(MBA), and Brock Cooper, General Counsel for
Veterans United Home Loans.
London explained that
there are two types of VA refinances. The
IRRRL, is a streamline loan generally used to obtain a lower interest rate than
the existing mortgage, to reduce the loan term, switch from an adjustable to a fixed
rate, or to make energy efficient improvements to the property. It cannot be used to cash out equity. The second
type of refinance does allow for cash to be taken out.
Of the more than 1,500 lenders who originate
loans, London said, fewer than 10 appear to be guilty of churning. These lenders have focused almost exclusively
on IRRRLs, which, unlike VA originations and cash-out loans, do not require
underwriting or valuation determinations.
These lenders have targeted servicemembers and veterans who have
VA-guaranteed loans precisely because IRRRLs are relatively inexpensive and can
be completed quickly.
Cooper told committee members, “It does
not matter how much a refinance purports to save a Veteran homeowner if it will
take them a decade to recoup loan costs and fees that swell their loan balance.
That does not put Veteran homeowners in a stronger financial position because
they have less equity or may even be upside down on their home when they go to
sell. The same could be said for convincing someone to refinance into an
adjustable-rate mortgage without discussing the possibility for future rate
increases or the potential for additional costs and decreased equity when later
refinancing back into a fixed-rate mortgage.”
MBA’s Motley said, it is important to focus on
options that target churning while not impeding the ability of servicemembers
and veterans to obtain beneficial refinancing. The VA program is a unique entitlement, so while
MBA supports quick action to limit abuses, it needs to be done thoughtfully to
ensure that legitimate low-cost refinancing options for veterans are retained.”
He suggested that instituting a maximum recoupment
period for a borrower to break even could prevent lenders from charging
substantial fees in exchange for minor reductions in mortgage interest rates. Ginnie Mae could also require a net tangible
benefit test, such as required for FHA streamlined refinances, to ensure that
the terms of the refinance produce real benefits for borrowers. Limits on the
amounts that can be added to the principal balance would reduce equity
stripping, and targeted consumer financial education about churning can better
inform borrowers about the potential for abuse.
He concluded, “Many borrowers may not fully
comprehend the net economic impact of their decision to refinance, leaving them
vulnerable to situations in which they add substantial amounts to their overall
loan balance while achieving only small reductions in their monthly payments.
This is not what the program was intended to do, and these practices should be
put to an end.”