VA Loans – An In-Depth Analysis

In 1944, Congress passed the Serviceman’s Readjustment Act, also known as the GI Bill. As part of the bill, the Department of Veterans Affairs Loan Guaranty Program (VA Loan) was established. The VA Home Loan is a financing option for qualified Veterans and Active-Duty personnel for the purchase or refinancing of a home.

In recent years, there have been several misconceptions and/or myths about the VA loan, its use, its benefits, and its drawbacks. In this article, we are applying a data-driven approach to address some of these misconceptions, examine the market for VA loans, and discuss the opportunity. The data analyzed for this paper is open data: U.S. Census data (American Community Survey (ACS), Current Population Survey (CPS), and CPS Veterans Supplement), the Federal Reserve’s Survey of Consumer Finances (SCF), Home Mortgage Disclosure Act (HMDA) data1, and Ginnie Mae single family disclosure data. The analysis was performed by Polygon Research in collaboration and with input from Vetted VA to inform the interpretation of the data.

In this article, we focus on 5 common statements about the VA Loan.

  1. What the VA loan is and what it is not.
  2. VA loans are difficult and do not close.
  3. VA loans are expensive for veterans.
  4. Veterans are better off renting rather than taking a VA loan.
  5. Veterans are better off borrowing FHA or Conventional than VA loan.

Let’s review each one of these claims considering the data that can shed light on whether these 5 common statements are valid.

#1: WHAT THE VA LOAN IS AND WHAT IT IS NOT.

The VA loan is a benefit that a veteran has earned. The VA loan is a financial instrument, subject to regulation and disclosure just as other types of financial instruments. The Department of Veteran Affairs (VA) does not directly lend money, but guarantees/protects lenders against loss up to the amount of the guaranty in the event of foreclosure. The VA benefit can be used multiple times and the funding fee will vary for subsequent uses.

When a lender underwrites a VA loan, the lender follows the underwriting standards established in the VA Pamphlet (VA Pamphlet 26-7 Revised). The VA Lender Handbook (26-7) lays the groundwork for the fundamental baseline approval for a VA Guaranteed Loan.  The handbook covers and allows for many different scenarios and structures that even the secondary lending market would normally not approve.  For example, the veteran must have satisfactory credit history, but a specific score is not identified; and satisfactory repayment ability (stable income), but disability income can be utilized and grossed up to the Veteran’s benefit; residual income (net effective income minus monthly shelter expense) in accordance with regional tables; and an acceptable ratio of total monthly debt payments to gross monthly income even if this ratio far exceeds standard acceptable amounts other supporting factors can overcome this weakness.

As of 2020, if the Veteran had full entitlement, they would not have a VA loan limit. But with remaining entitlement, a Veteran’s VA home loan limit is based on the county loan limit where they live.  Since the VA guaranty covers 25% of the outstanding loan amount, it will be up to the individual lender to underwrite the VA loan based on its policy and its secondary market strategy for VA loans.

At $285,000, the median VA loan amount was the largest of all loan types in 2020 – see Chart 1 for comparison of loan amounts by loan type. 

Chart 1: Median Loan Amount for Home Purchase by Loan Type, 2020

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Source: HMDAVision, 2020 HMDA LAR Data, 1-4 Units

#2: VA LOANS ARE DIFFICULT AND DO NOT CLOSE.

There are anecdotes from a variety of sources that VA loans are difficult to process and that they do not close, or do not close on time. Using that mindset as a starting point we took a closer look at this. The data source for this analysis is 2020 HMDA data modeled in HMDAVision, an interactive web app. HDMAVision facilitates extremely granular insights into pull-through, the loan life cycle of every loan and lender at the nation, state, county, and census tract level, in combination with borrower demographics and loan attributes. As we see in Table 1, VA Loans have a denial rate of 7.1% that is the lowest denial rate among all loan types. 

Table 1: Comparing Denial (Decline) Rates of Home Purchase Applications Among Loan Types

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Source: HMDAVision, 2020 HMDA LAR Data, 1-4 Units

Shifting our focus from denials to originations, as shown in Table 2, VA Loans have an originations (funding) rate of 72% that is 4 percentage points higher than Conventional and 5 percentage points higher than FHA loans. 

Table 2: Comparing Origination (Funding) Rates for Purchase Mortgages Among Loan Types

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Source: HMDAVision, 2020 HMDA LAR Data, 1-4 Units

An experience-based conclusion is that the issue is not with the VA loan itself, but with the expertise and experience of the lender and/or Realtor engaged in VA lending. Borrowers looking to use VA loans to finance their homes would benefit from working with experienced VA lenders who can capably guide them through the process from start to finish.

#3: VA LOANS ARE EXPENSIVE

The VA Home Loan program is a Veteran’s benefit. The VA policy objective is helping the veteran use his or her home loan benefit. Therefore, VA regulations limit the fees that the veteran can pay to obtain a loan (see Chapter 8: Borrower Fees and Charges and the VA Funding Fee). According to VA lending guidelines, “lenders must strictly adhere to the limitations on borrower-paid fees and charges when making VA loans”3.

To get insight into pricing, we used the publicly disclosed HMDA data, once again modeled in HMDAVision. In Table 3, we compare the pricing of the four major loan types by a variety of dimensions, including CLTV, Points, Credits, Originations Charges, Interest Rate, Rate Spread, and Closing costs. Here we will emphasize the Closing Costs and Interest Rate.

Table 3: Comparison of Pricing by Loan Types (Focus on Home Purchase)

Source: HMDAVision, 2020 HMDA LAR Data, 1-4 Units

Even though the VA purchase loan has 100% CLTV, it still has the lowest origination charges (incl. appraisal and underwriting fees), the lowest interest rate, and the lowest rate spread. This is a direct expression of the VA loan as a benefit to the veteran. 

Veterans are not required to take 100% CLTV loans, but many choose to do so, as their monthly payments on a 100% financing loan can be affordable (absent PMI). If a veteran had taken out the median Conventional loans size shown in Table 3, he or she would have paid on average a down payment of $66,250 for a loan with a higher interest rate. The size of the down payment in this scenario can be important in light of veteran or active duty borrower timelines for homeownership and competing investment strategies for the cash that would otherwise go into a down payment. 

CLOSING COSTS

Closing costs as presented here are the sum of all costs that the borrower (including the veteran) pays to close the loan. These may include origination charges, discount points, appraisal fees, recording fees, Title insurance, etc. In the case of the VA loan, the closing costs may include the VA Funding Fee when it is not waived2. The funding fee is a one-time, upfront fee that the veteran pays to the VA. Nationally, HMDA data shows that the median VA Closing costs are about $2,200 higher than the median closing costs of Conventional Loans, but about $1,820 lower than the closing costs on a FHA loan. It is important to note that the FHA loan also has an upfront fee of 1.75% of the loan amount for PMI (called UFMIP) that is paid at closing whereas the VA Funding Fee is 2.3% for first time use.  Both the VA Funding Fee and the UFMIP for FHA are added to the loan and financed through the loan amount. 

To get a deeper understanding of this issue of costs, we looked at the distribution of closing costs for Conventional-Conforming purchase mortgages vs. the distribution of closing costs for VA purchase loans. As we observe in Chart 2, the VA distribution is flatter, with 15% of loans with $2,000 or less in closing costs, which is almost 5 percentage points higher than this proportion for the conventional loans. It is expected that the funding fee will increase the closing costs but as this analysis shows us, the share of VA borrowers getting lower closing costs is higher than the share of Conventional borrowers getting lower closing costs. In addition, the closing costs are waived for VA borrowers with service-related disability and in a few other cases.

Chart 2: Purchase Closing Costs Distribution 

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Source: HMDAVision, 2020 HMDA LAR Data, 1-4 Units

One thing to keep in mind is that there is a great variability of closing costs by location. For example, VA borrowers in Arkansas are paying the lowest closing costs ($3,989) for the purchase of 1-4. And VA borrowers in DC, Hawaii, and the islands are paying the highest closing costs – upward of $14k.  

INTEREST RATES AND RATE SPREAD 4

Analyzing the HMDA LAR data, we observe that a VA loan carries the lowest interest rate and has the lowest spread. 

Chart 3: Median Interest Rates and Rate Spreads for Purchase Mortgages 

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Source: HMDAVision, 2020 HMDA LAR Data, 1-4 Units

Interest rate and points are negotiated between the lender and the veteran. According to the VA Pamphlet, “the veteran and seller may negotiate for the seller to pay all or some of the points. And the points may not be financed in the loan except with Interest Rate Reduction Refinancing Loans (IRRRLs).”

An important feature of the 100% CLTV VA loan that distinguishes it from other loans like FHA and Conventional loans is that the veteran does not have to pay additional private mortgage insurance (e.g. in the case of Conventional loans with above 80% CLTVs) or premiums (e.g. in the case of FHA loans). This is a significant benefit as it helps keep the monthly payments low for the borrower of a VA loan.

#4: VETERANS ARE BETTER OFF RENTING RATHER THAN TAKING A VA LOAN WITH $0 DOWN PAYMENT.

This depends on the individual situation of each veteran. Defining “better off” as having a higher net worth, we used the latest available Survey of Consumer Finances (SCF), a tri-annual survey administered by the Federal Reserve, to compare the net worth of veterans who own their homes with a VA loan to veterans who rent their home. When we look across the entire veteran population, we see that veteran homeowners have significantly higher net worth – 18x higher – than veterans who rent their home. Moreover, veterans who rent their homes are older than the veterans who own their home, which is the opposite of the general population. 

Table 5: Veteran Net Worth Comparison

OwnershipMedian AgeMedian Net WorthCount
Rented55$           8,5304,938,726
VA/Other51$      155,7053,633,020

Source: 2019 SCF Data, Tabulated by Polygon Research. 

But we also wanted to go farther and explore the delta between payments of veterans who pay mortgage5 or rent, in Table 6. We compared the share of wallet, i.e. the ratio of gross mortgage and gross rent payments as percent of their household income, and calculated a “delta”. The closer the delta between the share of wallet for mortgage and rent, the less important is the debate of rent vs. buy. For this analysis, we used the American Community Survey (ACS).

Table 6: Comparison of Rent vs Mortgage Payment of Veterans by Generation

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Source: CensusVision, 2019 ACS 1-Year PUMS Data. The table above includes only veterans (i.e. excludes those currently on active duty or training for the National Guard).

Across generations, veterans are paying less of their household income to cover their gross mortgage payments than their rental payments. On average, veterans pay ~27% of their household income toward rent payments, and only 20% of their household income toward a mortgage payment. Table 6 also breaks down this KPI further by generation. The youngest (Gen Z) and the oldest (Silent Gen and the Greatest Gen) veterans pay the highest rent payments as percent of their household incomes. 

When we consider that veteran-homeowners with a VA loan have 18x higher net worth than veteran-renters, and that veteran-homeowners with a mortgage pay only 20 percent of their household income in mortgage payments vs. veteran-renters who pay 27 percent of household income in rent payments, we may reasonably conclude that veterans are not better off renting than taking a VA loan to buy a home. The VA loan benefit allows veterans to own their homes, with the option to finance the whole loan, and without the requirement for private mortgage insurance.

#5: VETERANS ARE BETTER OFF BORROWING FHA OR CONVENTIONAL THAN VA LOANS.

This depends on each individual veteran’s situation, but we will try to address it as objectively as possible. 

First, let’s look at the most recent Survey of Consumer Finances in order to answer the question why borrowers choose VA loans. Scoping the survey responses to those where either the respondent or his or her spouse had military service, veterans’ top 3 reasons given for choosing VA6 loans were low interest rate, availability of special features for first time homebuyers, and down payment. 

Second, with the same scope, we looked in the SCF data to see what percentage of veteran mortgage holders chose the VA loan. As Chart 4 highlights, 42% of veterans chose VA loans, 44% chose Conventional, and 13% chose FHA loans. At the same time, among homeowners owning free and clear, veterans outstrip non-veterans 35% to 23%, which calls into focus the fact that many veterans have already used the VA loan as a path to full ownership. This perspective fuels the need for lenders and real estate agents/brokers who want to serve their entire community, including veterans, to educate themselves about the mechanics of VA loans in order to meet the market demand of veterans.

Chart 4: Veterans Choice of Mortgage

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Source: 2019 SCF Data, Tabulated by Polygon Research. 

Next, let’s focus on Minority Borrowers. Once more taking the 2020 HMDA LAR Data, we looked at the origination rate for minority borrowers by type of loan. Minority borrowers taking VA loans to finance the purchase of their home had a higher closing rate (68.8%) than Conventional loans (66.9%), and a higher origination rate than FHA loans (64.3%) as well. From a minority borrower perspective, if the borrower is eligible for a VA loan, he or she will be equally efficiently served by both the VA loan and the Conventional.

Table 7: Comparison of Minority Purchase Originations Rates Among Conventional, FHA, Rural, and VA Loans 

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Source: HMDAVision, 2020 HMDA LAR Data, 1-4 Units

If we narrow down the analysis to minority borrowers with 100% CLTV, 86.2% of those who applied for VA loans got funded vs. only 71.8% of minority borrowers with 100% CLTV who applied for Conventional loans.

Chart 5: Comparison of Minority Originations Rates Among Conventional, FHA and VA Purchase Loans with 100% CLTV 

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Source: HMDAVision, 2020 HMDA LAR Data, 1-4 Units

In fact, when we examine the loan type mix for minority borrowers of 100% CLTV, the VA loan has the highest share (76%). In 2020, the usage of VA purchase loan with no down-payment increase about 19% while the usage of Conventional and FHA loan decreased (See Chart 6).

Chart 6: Year-over-Year Change of Home Purchase Originations for 100% CLTV loans to Minority Borrowers

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Source: HMDAVision, 2020 HMDA LAR Data, 1-4 Units

The VA loan enables minority borrowers who have earned this benefit to buy homes. Homeownership is an opportunity to create generational wealth and close the wealth gap between minority and non-minority households. In fact, the homeownership gap is only 5.8 percentage points in the veteran community between minority and non-minority homeowners who recently moved (based on 2019 ACS analysis via CensusVision), vs. 10.9 percentage points in the population with no military service between minority and non-minority homeowners who recently moved.

Finally, we come to the question about the role of the lender in making sure that the VA loan is the right fit for the borrower. VA lending is not monolithic. Up to this point, we have looked at the VA lending on average, nationally, using measures of central tendency and histograms. But to examine it closer, we zeroed in on one state, Arkansas, to see if the closing costs are only geographically determined, or if lenders might play a role in differences. We chose Arkansas, because at a state level it has the lowest median closing costs (just under $4k), and we looked at all lenders in Arkansas who funded VA purchase loans in 2020: 198 lenders7. Below is a summary of the lender landscape with market players in VA Purchase Mortgage Market by type and market share.

Chart 7: Arkansas Lender Landscape

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Source: HMDAVision, 2020 HMDA LAR Data, 1-4 Units

With the caveat that the publicly disclosed HDMA data does not include the borrower’s FICO, we analyzed the distribution of VA closing costs, interest rates, and other metrics in 2020 on VA loans for purchase of site-built, primary residence with first lien, closed-end, forward mortgages8. Depending on the lender, its strategy, its LO workforce, and many other intangible things, we saw a great range of closing costs by VA Lender – from $0 to $18,838. The same was true for the distribution of VA loan interest rates in this state – from 2.25% to 4.63%; for loan size – from $85k to $515k, and so on. 

We then limited the geographic scope to one MSA, Little Rock, and still saw the same pattern of wide variability of pricing by VA lenders. Next, we chose one DTI range, 36%-43%, and the pattern of a wide range of closing costs by VA Lender – from $0 to $18,225 – persisted. Finally, we further limited the analysis to the above DTI range of 36%-43% to a specific loan amount range, $200,000-$250,00, only to get a similar wide range of closing costs by VA Lender – from $0 to $10,430; of interest rates – from 2.38% to 4.50%; and of rate spreads – from -0.57 to 1.55.

This data is evidence of something that has happened in the real world, and we have done our best to understand the world of VA lending through data analysis. But there is so much more that happens between a VA lender and a borrower/veteran – conversations and negotiations, the exchange of emails, documents and loan offers – that are not captured in the data, and which we therefore can’t analyze. But the existing data on VA lending is powerful in that it allows us to see the results of what has happened. And what we see is that what veterans pay for their purchase mortgages varies widely by VA Lender. It is important that lenders are knowledgeable about the ins and outs of VA lending, and that they continue to improve their understanding of the veteran community they serve. Coaching and educating individual Loan Officers and raising the bar of service ensures both that the veteran receives a good loan offer and that the VA loan application is processed at least as quickly as a conventional loan. 

CONCLUSION

In this article, we examined the VA loan: how it is viewed by veterans, how it is used, and what role it plays in the mission to improve homeownership. The VA loan is unique in that it is both a financial instrument and an earned benefit for the veteran (and military personnel on active duty). As such, it is governed by policy and procedures that aim to protect the veteran from predatory practices. Based on the analysis in this article, we believe that the VA loan is a competitive and viable option for U.S. veterans, and that it is an important financial instrument for veteran homeownership, in some ways especially for minority veterans. 

The question then becomes not whether a VA loan is bad or good, or whether a veteran should use his or her VA loan benefit, but rather about awareness about the VA loan and how it is currently used by lenders to serve our veterans. Anecdotally, in our conversations with industry stakeholders, we’ve heard that real estate agents can be uninformed about VA loans, and can discourage both sellers and buyers from using the VA loan in a real estate transaction. We’ve also seen during many VA lending analyses we’ve done that some lenders provide better loan offers to VA borrowers than others in terms of rates, points, fees, and closing costs. We encourage all stakeholders to engage in a rich discussion and to learn more about our veterans, VA lending, and to understand in their local markets, who are the VA lenders, and how they are currently serving our veterans. Actively collaborating and/or partnering with these lenders to learn best practices is one way to improve the current level of misconception regarding the VA loan and lending process. Along with this, we believe there is a huge opportunity to improve the VA lending experience through data for all stakeholders, chief among them veterans.

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