Secret #49 – The VA Has a Lot More Zero Down Payment Mortgages Than FHA But the VA Has FEWER Foreclosures!
Despite the VA having many $0 down payment mortgages, their foreclosure rate is sometimes half of FHA’s foreclosure rate.
Having zero down payment increases the risk for foreclosure but the VA compensates with other measures that more than offset that increased risk. A ton of factors go into determining the riskiness of mortgages.
What can we learn from VA mortgage design?
Skin in the Game. As discussed above, VA only covers up to 25% of the mortgage industry losses from VA mortgages so the mortgage industry somehow ends up making safer mortgages. FHA covers 100% of mortgage industry losses from FHA mortgages so their FHA mortgages somehow have a higher foreclosure rate.
Appraisers and Appraisals. Unlike FHA, and Fannie and Freddie, the VA assigns the appraisers. Mortgage companies don’t assign the appraisers on VA mortgages. That helps keep the appraisers independent. VA-approved appraisers are assigned on a rotating basis. When an appraisal comes in below the contract price, the VA is still going to hire the appraiser in the future. In fact, that’s the way FHA did it before 1994.
As part of their quality control system, the appraisals of VA-approved appraisers are occasionally reviewed for accuracy by other VA-approved appraisers.
In the rest of the mortgage industry, the appraisers are chosen by the buyers’ mortgage company – they work for the mortgage company – which tends to lead to higher appraisals (“appraisal bias”) because the appraisers don’t want to complicate or kill the mortgage company’s sale with a “low” appraisal unless the contract price is WAY below fair market value. They don’t want to risk not getting any more appraisal business from that mortgage company just because the appraised value is a few percentage points below the price the buyer and seller agreed to in the contract.
Part of the problem with “low” appraisals is because appraisals are typically done right before closing which greatly complicates things when they come in below the purchase price. If appraisals were done earlier in the process, low appraisals wouldn’t be so catastrophic for everyone involved.
Residual Income. VA not only looks at debt-to-income ratios but also “residual income” which makes the mortgages safer and helps reduce future foreclosures.
Seller Concessions. VA has a 4% cap on seller concessions. FHA has a 6% cap on seller concessions.
With FHA you can get situations where the buyer pays more than fair market value (because of a high appraisal = appraiser bias) and the seller contributes up to 6% of the value of the house to the buyer. Foreclosure risk is higher. That’s less likely with VA because their appraisals are more accurate and their cap on concessions is lower. Those are some reasons why VA $0 down payment mortgages have a lower foreclosure rate than FHA mortgages.
Source: A lot of the information on FHA and VA mortgages here I learned from Ed Pinto at AEI, for example, here, here, here, and here.
Are zero-down FHA loans still subject to PMI? I know VA loans aren't (at least mine haven't been) and that extra several hundred dollars a month for payments might also be a factor.