The Surprising Safety of a Zero-Down Mortgage

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ShutterstockThe zero-down loans offered by the Veterans Administration might provide lessons for the lending industry.

The safest mortgage on the market since the housing crash is one where most buyers put $0 down. Wait, huh? Welcome to the surprising world of VA home loans.

About 9 in 10 buyers using this historic benefit program purchase without making a down payment. Despite that, these government-backed mortgages have had the lowest foreclosure rate of any loan type for 19 of the last 26 quarters, according to figures from the Mortgage Bankers Association. The safety and stability of the VA loan program remains one of the more under-reported trends in all of housing. An Urban Institute study released this past summer highlighted the VA's foreclosure track%VIRTUAL-pullquote-Since 2008, the VA has helped more than 320,000 homeowners avoid foreclosure, saving an estimated $11 billion in potential foreclosure claim payments.% record, but it's a mostly under-the-radar success story. That's not to say the lending industry needs some seismic shift away from "skin in the game." There's clearly a benefit to and place for down payments.

VA loans are also a hard-earned benefit reserved for those who serve our country. It's a special program, and it should stay that way. But these zero-down loans do offer some lessons worth a closer look.

Big Benefits: VA loan volume has soared 372 percent since the crash, driven mostly by a tighter lending climate, a tough economy and bottom-barrel interest rates. VA loans feature more flexible and forgiving requirements than conventional loans, including lower credit score benchmarks, no mortgage insurance and closing costs limits.

But the single-biggest benefit is the ability to purchase with $0 down. Qualified borrowers in most parts of the country can purchase up to $417,000 before needing to factor in a down payment.

Since 2008, nearly 90 percent of VA buyers have purchased without a down payment. Yet, for almost five full years, these loans had a lower foreclosure inventory rate than all others, including prime loans.

The reasons why have a lot to do with common-sense underwriting and a commitment to helping veterans not just get into homes but keep them.

Residual Income: One is VA's unique requirement for discretionary income. This standard, known as residual income, requires borrowers to have a minimum amount of money left over each month after paying their mortgage and other major expenses. How much varies based on geography and family size.

For example, a family of four in the Midwest would need at least $1,003 in residual income each month. Buyers with a debt-to-income ratio above 41 percent must meet an even higher benchmark and exceed the guideline by at least 20 percent.

Debt-to-income ratio is still the major focus in mortgage lending. But residual income can offer a more realistic look at affordability and a borrower's ability to keep up with their mortgage payments if emergencies occur.

Closing out its look at why VA loans outperform FHA in terms of default, the Urban Institute encouraged other loan programs to consider adopting a residual income standard.

"We believe this test can be a powerful indication that the borrower will find the mortgage payments sustainable," the authors noted. "We believe the residual income test can have applicability beyond the VA market."

In addition, unlike with FHA financing, the VA guaranties only a portion of the loan in case of default. Lenders pay a steeper price when loans go sour, which has historically encouraged flexible-but-prudent underwriting.

Helping hands: The VA doesn't actually make or directly service home loans, but it has the authority to intercede on behalf of borrowers on the edge. More than 150 loan program employees focus solely on homeowners facing default.

These foreclosure specialists receive a notification whenever a VA-backed loan is more than 60 days past due. They follow up directly with the veteran and often push lenders to offer alternatives to foreclosure, like loan modifications, repayment plans or forbearance.

Since 2008, the VA has helped more than 320,000 homeowners avoid foreclosure, saving an estimated $11 billion in potential foreclosure claim payments.

Veteran Makeup: VA borrowers themselves deserve a lot of credit for the program's success. You didn't see a lot of military members walking away from their homes during the peak of the foreclosure crisis.

This is a group that takes seriously the idea of duty and obligation, even when it comes to a mortgage payment. That sense of commitment is also applicable beyond the VA market.

But it's much tougher to instill.
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