Government-Program Loans Are Crucial to Mortgage Market Sustainability

As the housing market aims to increase the number of first-time buyers and stimulate overall sales activity, certain types of loan products are receiving increased attention. Foremost among those products are government-program loans, including those offered by the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA).

According to a recent Bloomberg report, VA loans are especially vital to the market's sustainability given the number of recently discharged soldiers returning stateside and looking to settle down. In that interest, the U.S. Department of Housing and Urban Development (HUD) has issued a directive urging mortgage insurers offering Freddie Mac or Fannie Mae loans to offer additional protections for military members seeking to buy their first homes. Currently, VA loans receive up to 25 percent backing from government-sponsored enterprises, but in order to enhance these first-timers' odds at mortgage fulfillment, HUD is asking private loan servicers to do more.

FHA's Losses Are Often VA's Gains

The impetus for private mortgage insurance adjustments is rooted in rising costs absorbed by the FHA, which has been unable to offer as many of the low-down-payment options for which it is best known at a time when millions of service personnel have returned home. Consequently, VA lending has benefited, accounting for 9 percent of all mortgages during the second quarter of 2014 – the largest proportion in 20 years. Companies such as American International Group, Inc. (AIG) and MGIC Investment Corp. have been among the primary players in the mortgage market's expanded VA loan offerings, but smaller lenders can't always afford to assume the same level of risk.

"[The 25 percent cap on VA insurance] leaves a lot of small lenders awfully exposed and reluctant to offer veterans credit under this initiative," explained HUD Secretary Julian Castro, speaking at the recent Mortgage Bankers Association conference in Las Vegas. "[Additional protection would make them] feel confident when offering these loans – giving more of our nation's heroes a chance to buy a home in the country they risked everything to protect."

Currently, many of the smaller lenders that serve VA loans do so by selling contracts to larger entities, thereby alleviating default risk. VA loans don't require down payments from most eligible buyers – another reason FHA loans have seen reduced traffic over the past two years. With the majority of the 2.5 million-plus troops who have served in Iraq and Afghanistan since 2001 having returned home, it's no wonder interest in VA loans has spiked while the FHA has increased insurance costs to offset depleted funds. Fannie and Freddie loans have also garnered renewed interest, attracting buyers who otherwise may have opted for FHA loans before down payment and insurance costs were adjusted. But the government-program loans still provide the most direct and affordable path to homeownership for a lot of first-time applicants.

The Changing Environment

Mortgage insurers, meanwhile, stand to gain as the shift toward private mortgage lending takes hold. According to data compiled by the Mortgage Bankers Association, nearly 15 percent of all home loans were backed by private entities during the third quarter of 2014, and that trend may only be furthered as Fannie and Freddie's roles continue to evolve. If there's incentive to do so, it seems most private insurers will pick up the additional costs that come with VA loans, as well. There's no doubt about one thing: The veteran market is as full of eligible homebuyers as any demographic, especially at a time when traditional mortgage credit qualification terms have been more restrictive.

"As private capital we certainly would like to explore as many ways as possible to prudently participate in the housing recovery and expansion," Mike Zimmerman of MGIC told Bloomberg, adding that supplemental insurance would be included in that expansion.

Pending changes to the secondary mortgage market – specifically regarding the future of GSEs such as Fannie Mae and Freddie Mac – make the question of whether more private lenders will absorb VA loan risk difficult to answer. There's no doubt the number of eligible homebuyers equates to opportunity for a number of private organizations, but uncertainty about the industry's future can make such entities non-committal. Fannie and Freddie have already announced plans to create a common securitization platform, and though it may be part of a multi-year transition, that initiative is in line with the presumed goal of reducing the GSEs' collective footprint and streamlining the secondary mortgage market as a whole.

The FHFA still oversees Fannie and Freddie operations, while the VA and FHA operate independently. Going forward, eligible homebuyers may find that government-program loans with the most favorable terms are also the most widely available, especially in an environment where the Qualified Mortgage rule's specific qualification terms forces many private entities to either seek other options or remove themselves from the mortgage market entirely.