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As lenders targeted veterans with risky mortgages, VA failed to act

The Department of Veterans Affairs has known for more than a year that military service members were being sold a flood of costly and risky mortgages and done little to stop it. The result: Borrowers have been saddled with thousands of dollars in fees, and interest rates have risen for millions of rank-and-file homeowners.

Lenders, hunting for business in a slow market, have swarmed into VA mortgages, sometimes selling military homeowners new loans every few months. Some are pushing short-term adjustable-rate mortgages even as interest rates climb. The churn adds fees at every turn, driving homeowners deeper into debt.

“Lenders are abusing veterans,” said Ted Tozer, a senior fellow at the Milken Institute and former president of Ginnie Mae, a corporation that manages government-backed mortgages. “It’s predatory. These veterans keep going further and further in the hole.”

Tozer and others told POLITICO that the VA has had a fix in the works since the spring of 2016 but has yet to finalize it, something agency spokesman Curt Cashour confirmed this week.

The delay has frustrated lawmakers, veterans and the mortgage industry. It has also spooked Wall Street, where investors are losing their appetite for Ginnie Mae mortgage bonds. That has led to higher interest rates for homeowners — civilian and military — who take loans backed by the VA, the Federal Housing Administration and the Department of Agriculture. Through higher rates, FHA and USDA borrowers are, in effect, subsidizing VA mortgages.

Pensions and retirement funds, too, have been bruised as VA mortgages held as long-term investments vanish within months. Wall Street was the first to sound alarms last year after bond traders noticed VA loans paying off at an astounding rate.

The problem took on new urgency this fall. Tozer had required that by February of this year certain VA loans had to be six months old before they could be sold into some Ginnie Mae bonds. It was a short-term solution designed to give the VA time to find a remedy. It quieted the market, but only temporarily.

But when the six-month period expired, the churn was back. In July, Ginnie Mae’s new acting president, Michael Bright, was shocked to see erratic behavior in the agency’s bonds. He doubled pressure on the VA and alerted lawmakers to what was happening.

“VA is aware that some lenders have chosen to pursue a market niche in serial refinancing,” Cashour, the agency spokesman, said in a written statement. “The department is currently evaluating potential regulatory or policy changes that may help ensure that interest rate reduction refinance loans are beneficial to borrowers and do not have undue negative effects on other key stakeholders.”

Absent action from Veterans Affairs, Bright has used his limited authority to fine lenders and keep VA loans from tainting FHA and USDA mortgages. But only Veterans Affairs can rein in lenders, for example by requiring them to demonstrate that a refinancing benefits the borrower. The FHA already compels lenders to show a “net tangible benefit” to borrowers before selling them a streamlined refinance.

“The right way to do it would be for VA to tighten up their loan program,” Bright said. “I’m on the tipping point of frustrated.”

In the meantime, Bright is flagging suspect loans to the Consumer Financial Protection Bureau and plans to further restrict the VA refinancings he allows into Ginnie’s bonds. Mortgage servicers that break the rules could be banned from the program.

“We’re going to take some substantive action before the holidays,” Bright said. “Things are moving fast.”

The problem began with rising mortgage rates. For a decade, cheap borrowing had homeowners refinancing at a rapid clip. When rates started climbing, the music stopped. Lenders needed new ways to make money.

Veterans looked like a good bet. Once a niche market, their numbers had grown, and those who owned homes had enjoyed a run of rising home prices, so they had equity. And a VA program — the Interest Rate Reduction Refinance Loan — was a slam dunk. It allows lenders to put existing VA borrowers into lower-rate loans without an appraisal or underwriting.

Pitches crowded veterans’ mailboxes, some disguised as government checks or notices from the Department of Defense. Fine print hid the bad news that the low-low mortgage rate was sometimes a teaser. Fees were rolled into the loans, leaving borrowers with more debt, a practice known as equity stripping.

“Let’s face it, the industry is in a state of panic. That’s what’s going on right now,” said Joe Murin, a board member of NewDay Financial, a VA lender. “After 10 years of refinancing, all of a sudden it’s like, oh hell, what happened?”

The churn is lowering veterans’ monthly mortgage payments, but the new loans aren’t always a good deal. On fixed-rate refinancing, a veteran might pay $6,000 to lower payments by only $98 a month, according to Bright. Refinancing from a fixed- to an adjustable-rate loan might cost $12,000 and save the service member $165 a month — a recoupment period of more than six years.

And the process is self-perpetuating. Lenders are refinancing some VA borrowers who have made just one payment on their existing loan. The refinance lowers the rate, but can leave the borrower owing more than the house is worth. Sometimes the lenders upgrade the borrowers’ credit scores, making them ripe for even more refinancing.

“It’s unacceptable,” Bright said. “This is similar to pre-financial crisis behavior where the seeming belief was rates would stay low forever and home values would continue to increase.”

The American Legion has asked the Senate Banking Committee for hearings, and lawmakers in the House and Senate are considering legislation that would force the VA to impose limits on streamlined refinancings. Congressional aides say they’ve gotten scant information or response from the VA.

In early October, House Veterans’ Affairs Chairman Phil Roe (R-Tenn.), circulated a draft bill that would make it easier for the VA to make changes to the program. Roe’s office has yet to receive feedback from the agency on the proposal.

In the Senate, Thom Tillis (R-N.C.), a member of the Armed Services and Banking committees, is drafting legislation and has endorsed the idea of requiring VA lenders to show a net tangible benefit to borrowers. That might include requiring that fees be recouped in a reasonable number of months, or limiting when fees can be added to a loan’s principal balance.

Senate Banking Committee members Dean Heller (R-Nev.) and Elizabeth Warren (D-Mass.) have also raised concerns with VA Secretary David Shulkin. The Mortgage Bankers Association and Wall Street are pressing the agency to act.

“Consumers, including veterans, may be being harmed. We know investors are being harmed. Borrowers from FHA are being harmed,” said Chris Killian, managing director and head of securitization at SIFMA, which represents the securities industry. “The sooner they fix it, the better. It’s all around bad for everybody.”

Some VA lenders are pushing back against new restrictions. Meanwhile, the churning continues and frustration is growing.

“They’re not reacting to this in any way with any type of urgency,” said one GOP aide. “It shouldn’t take that long for someone to pay attention.”

VA loans accounted for one in 10 new mortgages in the first nine months of this year, according to Inside Mortgage Finance, a 10-fold growth in market share from a decade ago.

Bond analysts at Citi and JPMorgan have singled out VA lenders whose loans are being refinanced at a rapid clip. Chief among them is Freedom Mortgage Corp.

The Mount Laurel, N.J.-based company had nearly $15 billion in loans last year, more than 75 percent of which were streamlined refinancings, making it the country’s biggest VA lender, according to Inside Mortgage Finance.

Freedom recently paid a fine after it broke a new Ginnie rule requiring loans to be at least six months old before being pooled into certain government-backed bonds.

CEO Stan Middleman called the penalty “negligible.” The error, he said, was “a foot fault and not us doing something purposefully.”

“We’re being judged unreasonably and being thrown in with people who aren’t doing the right thing,” Middleman told POLITICO. “I’m a little bit ashamed of the industry for behaving the way they do.”

Middleman said his company applies its own tangible benefit test to ensure veterans are getting the right loans. He backed the idea of extending Ginnie’s seasoning requirements from six months to 12 months.

“Every borrower has to be better off after we’re done with them than before we did business with them,” he said.

Wall Street analysts are also watching NewDay, which specializes in debt consolidation and higher-risk borrowers with imperfect credit.

Murin says his company is a victim of refinancing churn. NewDay borrowers are being refinanced out of 100 percent loan-to-value mortgages into 90 percent loan-to-value mortgages within months, he said. Then their credit scores go up and they refinance again. With each new loan, fees are added to borrowers’ costs.

In effect, the VA’s streamlined finance program has been turned against veterans, he said, and the agency needs to act.

“They need an a-ha moment,” Murin said. “This is something that has to stop.”

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