Finance_12 Instructor Materials.docx

12. VA-Guaranteed Loans Learning Objectives After completing this lesson, students should be able to… List the characteristics that distinguish VA-guaranteed loans Describe the criteria for eligibility for a VA loan Define the role of the VA guaranty and how it affects the VA loan amount Illustrate...

12. VA-Guaranteed Loans Learning Objectives After completing this lesson, students should be able to… List the characteristics that distinguish VA-guaranteed loans Describe the criteria for eligibility for a VA loan Define the role of the VA guaranty and how it affects the VA loan amount Illustrate how a substitution of entitlement works Calculate how much of a downpayment will be needed for a particular loan Describe VA underwriting guidelines List compensating factors that might help a marginal applicant obtain a VA loan Suggested Lesson Plan 1. Give students Exercise 12.1 to review the previous chapter, “FHA-Insured Loans.” 2. Provide a brief overview of Chapter 12, “VA-Guaranteed Loans,” and review the learning objectives for the chapter. 3. Present lesson content: Characteristics of VA Loans Eligibility for VA Loans – Service requirements – Eligibility of spouse VA Guaranty – Guaranty amount – Restoration of guaranty entitlement – Entitlement and co-ownership – Refinancing with a VA loan EXERCISE 12.2 Characteristics of VA loans EXERCISE 12.3 Comparing VA and conventional loan features VA Loan Amounts – Making a downpayment – Secondary financing Underwriting Guidelines – Income ratio analysis – Residual income analysis – Compensating factors EXERCISE 12.4 VA underwriting 4. End lesson with Chapter 12 Quiz. Chapter 12 Outline: VA-Guaranteed Loans I. Characteristics of VA Loans A. VA loan is made by institutional lender, but a portion of loan amount is guaranteed by the Department of Veterans Affairs 1. Loan guaranty functions like mortgage insurance, protecting the lender against a loss if the borrower defaults B. Key characteristics of a VA loan 1. VA loan can be used for purchase or construction of residence with up to four units (or refinance) 2. Veteran must occupy the home (or one of the units in a multifamily residence), which generally must be principal residence 3. No downpayment generally required, as long as loan doesn’t exceed home’s appraised value 4. No maximum loan amount 5. No maximum income limit 6. Less stringent qualifying standards 7. No mortgage insurance required 8. No prepayment penalty allowed 9. May be assumed by a veteran or a non-veteran 10. Forbearance extended to borrowers with temporary financial difficulties C. VA borrowers generally pay a funding fee from 1.25% to 2.15% of the loan amount, depending on the downpayment; fees may be slightly higher or waived in some situations II. Eligibility for VA Loans A. Eligibility requires a period of service 1. 24 months of continuous active duty; or 2. the full period for which the veteran was called to active duty, so long as that was at least 90 days, any part of which occurred during wartime; or 3. at least 181 days of continuous active duty during peacetime B. Six years of service in the Reserves or National Guard even without fulfilling the minimum active duty requirement C. Shorter period of service required for disabled veterans or veterans discharged early for government, hardship, or medical reasons D. An eligible veteran is issued a Certificate of Eligibility, which the vet uses to apply for a VA loan E. The spouse of a veteran who was killed in action, died of service-related injuries, or is listed as missing in action or as a prisoner of war, may be eligible for a VA loan III. VA Guaranty A. Guaranty available to a particular veteran is known as the veteran’s “entitlement” 1. Guaranty amount depends on the size of the loan 2. Maximum guaranty (for loan amounts over $144,000) a. In most counties, maximum guaranty is 25% of the current Federal Housing Finance Agency conforming loan limit b. Each high-cost county has its own maximum guaranty amount based on the area median housing price B. Entitlement may be restored (and then reused) if veteran pays off loan in full 1. VA allows a one-time restoration of entitlement to a borrower who pays off VA loan without selling the property and wants another VA loan to buy one additional property C. VA loan may be assumed by a veteran or non-veteran 1. Generally, VA will issue release as long as loan is current and buyer is acceptable credit risk 2. If loan is assumed by a veteran who substitutes his entitlement, the original borrower’s entitlement is restored D. If spouses are both veterans, they cannot combine their entitlements to increase the guaranty amount for a single VA loan E. If a veteran buys a home with a non-veteran, the guaranty only applies to the veteran’s portion of the loan EXERCISE 12.2 Characteristics of VA loans EXERCISE 12.3 Comparing VA and conventional loan features IV. VA Loan Amounts A. No maximum VA loan amount, but loan generally cannot exceed property’s appraised value 1. VA-approved appraiser appraises the property; VA issues Notice of Value (NOV) B. Most lenders require guaranty to equal at least 25% of the loan amount; in other words, lender won’t make no-downpayment loan for more than four times the guaranty amount 1. In most areas, with the current maximum guaranty amount of $113,275, lenders generally won’t make VA loans for more than $453,100 without a downpayment C. If a VA loan amount is larger than four times the guaranty amount, the borrower must make a downpayment to make up the difference between the maximum guaranty amount and 25% of the sales price D. A borrower can finance part or all of a lender-required downpayment, as long as: 1. total financing doesn’t exceed property’s appraised value, 2. buyer’s income is enough to qualify based on payments for both loans, and 3. second loan is assumable by creditworthy buyer V. Underwriting Guidelines A. Applicant must qualify under two methods of income analysis: income ratio and residual income B. Income ratio method: borrower’s debt obligations are measured against income; debt to income ratio generally must be 41% or less C. Residual income method: borrower’s proposed monthly shelter expense, other recurring obligations, and certain taxes are subtracted from the gross monthly income to determine the residual income; the residual income should exceed the VA’s minimum requirement, which varies based on the borrower’s location, family size, and proposed loan size D. Lenders may make exceptions to the income ratio and residual income requirements if the loan applicant has compensating factors 1. Compensating factors include: good credit history, minimal debt, long-term employment, significant liquid assets, downpayment, high residual income, and a low debt to income ratio 2. If the applicant’s debt to income ratio exceeds 41% but the residual income is at least 20% over the required minimum, the lender may approve the loan without any other compensating factors EXERCISE 12.4 VA underwriting Exercises EXERCISE 12.1 Review exercise To review Chapter 11, “FHA-Insured Loans,” have students answer these questions. 1. Which of the following terms are associated with FHA loans? 100% financing (no downpayment required) Minimum cash investment Maximum loan amount Private mortgage insurance Mutual mortgage insurance Local loan ceilings 2. True or false? FHA programs are limited to applicants whose incomes do not exceed the area median income by more than 10%. 3. What are the standard income ratio limits for an FHA loan? Answers: 1. The terms “minimum cash investment,” “maximum loan amount,” “mutual mortgage insurance,” and “local loan ceilings” are associated with the FHA-insured loan program. “100% financing” and “private mortgage insurance” are not. 2. False. FHA programs don’t set maximum income limits. The programs target low- and moderate-income borrowers by tying loan amounts to median housing prices. 3. 31% housing expense to income ratio; 43% debt to income ratio EXERCISE 12.2 Characteristics of VA loans Read the following True/False questions aloud to students and have them jot their answers down on a piece of paper; discuss the answers together. 1. A VA loan requires only a small downpayment. 2. Although lenders limit the size of VA loans, the program rules do not specify a maximum loan amount. 3. A VA loan requires payment of a funding fee, but no mortgage insurance. 4. The federal government will reimburse the lender for all or part of the loss if a VA borrower defaults. 5. There are eligibility requirements for VA loans, but no qualifying rules. 6. The veteran’s guaranty entitlement is restored when a VA loan is paid off. 7. The guaranty amount available for a transaction does not depend on the loan amount. Answers: 1. FALSE. With a VA loan, the borrower is not necessarily required to make any downpayment at all. 2. TRUE. The VA’s rules don’t specify a maximum loan amount. As far as the VA is concerned, the only limitation on the loan amount is that it may not exceed the property’s appraised value. 3. TRUE. The funding fee serves a similar purpose as mortgage insurance premiums (no mortgage insurance is required for a VA loan). 4. TRUE. If a VA borrower defaults and the lender suffers a loss as a result, the federal government will reimburse the lender for the loss up to the loan’s guaranty amount. This may or may not cover the full extent of the lender’s loss. 5. FALSE. Only an eligible veteran can get a VA loan, but even an eligible veteran can’t get a VA loan unless she meets the VA’s qualifying standards. 6. TRUE. The veteran’s entitlement is restored when the loan is paid off, or when the loan is assumed by another eligible veteran who agrees to a substitution of entitlement. 7. FALSE. The guaranty amount that’s available to a veteran depends in part on the veteran’s entitlement and in part on the loan amount applied for. The maximum guaranty is larger for larger loan amounts. EXERCISE 12.3 Comparing VA and conventional loan features Activity: After class, have students look at websites or newspaper ads for at least three lenders that offer VA loans in the local area. Ask the students to compare quoted rates for 30-year fixed-rate conventional loans and 30-year fixed-rate VA-guaranteed loans. Which type of loan has a lower interest rate? Which has a lower APR? According to the fine print, what other charges are associated with each of the loans? EXERCISE 12.4 VA underwriting Discussion Prompts: 1. Irene, an eligible veteran, wants a VA loan to buy a home valued at $500,000. Her guaranty entitlement is $113,275. Assuming the lender follows the general practice concerning the relationship of the guaranty amount to the loan amount, how large a downpayment will Irene need to make in order to buy the house? 2. The Warners, a family of four, live in one of the states in the VA’s West region. They’ve found an 1,800 square-foot home, and they want a $200,000 VA loan, with monthly payments of $1,600. Their monthly income is $5,000. Aside from their housing expense, their monthly obligations consist of a $200 student loan payment and a $300 car payment. Do they qualify for the loan they want under the maximum income ratio test used for VA loans? 3. Now assume that the following amounts are withheld from the Warners’ earnings each month: $900 for federal income tax, $200 for state income tax, and $400 for Social Security and Medicare. Their estimated monthly maintenance and utilities amount is $252. What is their residual income? Do the Warners qualify for the loan under the residual income test? 4. Given their residual income, can the Warners qualify for the loan without any compensating factors? Analysis: 1. Lenders generally want the guaranty amount to be at least 25% of the loan amount. So Irene’s lender will require her to make a downpayment of $11,275= when she buys the $500,000 house. $500,000 × 25% = $125,000 – $113,275 = $11,275 downpayment. 2. No, the Warners don’t qualify based on the income ratio test. Their debt to income ratio is 42%—higher than 41%, the standard ratio for VA loans. $1,600 (housing) + $500 (debts) = $2,100 ÷ $5,000 (income) = 42% 3. The Warners’ residual income is $1,148. $5,000 (income) – $1,852 (monthly shelter expense) – $500 (debts) – $1,500 (taxes) = $1,148 For a family of four in the West with a loan amount over $80,000, the minimum residual income is $1,117. So the Warners meet the residual income test. 4. When a VA loan applicant fails the income ratio test, the loan can still be approved if their residual income exceeds the required minimum by 20% or more, even in the absence of any other compensating factors. However, the Warners’ residual income is only $31 more than the minimum, and that isn’t 20% more. $1,148 – $1,117 = $31 (amount over minimum) $1,117 ×.20 = $223 (20% of the minimum) Chapter 12 Quiz 1. A VA-guaranteed loan is originated by: A. an institutional lender B. state government agencies C. the Department of Veterans Affairs D. the Federal Housing Administration 2. Which of the following is NOT a characteristic of a VA loan? A. No downpayment is required B. The borrower will make annual mortgage insurance payments C. The loan may be assumed by anyone, including a non-veteran D. There is no maximum loan amount 3. The maximum guaranty amount available in a VA loan transaction: A. is 75% of the price or appraised value B. cannot exceed the borrower’s residual income figure C. is set by the lender, not the VA D. depends in part on the loan amount 4. Eligibility for a VA loan is based on: A. age, disability, and income level B. a superior officer’s recommendation C. length of active duty service D. a distinguished service record 5. The guaranty amount available to a particular veteran is also known as the veteran’s: A. entitlement B. guaranty balance C. liability D. residual income 6. If a loan amount is over $144,000, the maximum guaranty amount is: A. 25% of the loan amount, up to a maximum of 25% of the Federal Housing Finance Agency conforming loan limit for single-family residences B. 40% of the loan amount, up to a maximum of $36,000 C. 50% of the loan amount D. $22,500 7. How is a veteran’s full guaranty entitlement restored? A. A non-veteran buyer assumes the VA loan B. At least ten years have elapsed since the veteran’s last loan was issued C. The veteran receives a waiver of liability from the government D. The veteran sells the property and repays the loan in full from the proceeds 8. Tim and Teri are both veterans. They are buying a $450,000 house. They each have an entitlement of $113,275. Their guaranty amount would be: A. $113,275 B. $126,550 C. $208,500 D. $226,550 9. A VA loan can be used to refinance: A. only a VA loan B. a VA loan or an FHA loan C. a VA loan, an FHA loan, or a conventional loan D. None of the above; VA loans cannot be used for refinancing 10. The document issued by a VA-approved appraiser which sets forth the value of a property is known as a: A. Certificate of Eligibility B. Certificate of Reasonable Value C. Notice of Value D. Either B or C 11. A VA borrower is buying a $485,000 home. His entitlement is $113,275. How large a down­payment will a lender require him to make? A. $0 B. $7,975 C. $10,425 D. $21,750 12. Which of the following is the standard maximum debt to income ratio for a VA borrower? A. 33% B. 36% C. 41% D. 43% 13. The Evans family has a monthly income of $5,000. In order for them to meet the VA’s income ratio test, their monthly total obligations should not exceed: A. $1,650 B. $1,800 C. $2,050 D. $2,150 14. The Evans family has a monthly income of $5,000. They have $700 in recurring obligations each month, a monthly shelter expense of $1,500, federal income taxes of $420, state income taxes of $110, and Social Security and Medicare withholding of $330. They spend an average of $600 per month on food. What is their residual income? A. $2,050 B. $1,940 C. $2,950 D. $4,300 15. Which of the following factors would, without any other compensating factors, allow approval of a VA loan if the borrower’s income ratio is too high? A. Good credit score B. Reserve funds C. Residual income at least 20% over the required minimum D. Use of a downpayment Answer Key 1. A. VA loans are originated by institutional lenders. They are guaranteed by the Department of Veterans Affairs, which will reimburse a lender in the event of borrower default. 2. B. VA loans do not involve mortgage insurance. The VA guaranty provides the same type of protection as mortgage insurance, but the borrower does not pay an annual premium for it. 3. D. A larger guaranty is available for larger loan amounts. The available guaranty also depends on whether the veteran has full entitlement. 4. C. To be eligible for a VA home loan, a veteran generally must have served on active duty for at least a specified period. The minimum period is longer for peacetime service than for wartime service. 5. A. A veteran’s entitlement is the guaranty amount available to that particular veteran. 6. A. The maximum guaranty amount for loans over $144,000 is 25% of the loan amount, up to a maximum of 25% of the Federal Housing Finance Agency conforming loan limit for single-family residences. 7. D. If a veteran sells the property that he financed with a VA loan and repays the full loan out of the sale proceeds, his full guaranty entitlement is restored. It can also be restored if the loan is assumed by a veteran, but not if it’s assumed by a non-veteran. 8. A. A married couple, both of whom are veterans, may not combine their entitlements to increase their guaranty amount. 9. C. A VA loan can be used to refinance any type of loan, although the veteran’s guaranty entitlement must be used if a VA loan is used to refinance a non-VA loan. 10. D. The document establishing a property’s appraised value is known as a Notice of Value or Certificate of Reasonable Value. 11. B. Most lenders require the guaranty plus the downpayment to equal at least 25% of the sales price. If the sales price is $485,000, the guaranty plus downpayment must equal $121,250 ($485,000 ×.25 = $121,250). Subtract the guaranty from this amount to find that the borrower must put $7,975 down: $121,250 – $113,275 = $7,975. 12. C. As a general rule, a VA borrower’s debt to income ratio should not exceed 41%. 13. C. Since the maximum debt to income ratio for a VA loan is 41%, multiply $5,000 by 41%: $5,000 ×.41 = $2,050. The Evans family’s total obligations should be no more than $2,050 per month. 14. B. Residual income is determined by taking the applicant’s gross monthly income and subtracting recurring obligations, the monthly shelter expense, and certain taxes, including federal and state incomes taxes and Social Security and Medicare withholding. In this case, the residual income would be $2,090 ($5,000 – $700 – $1,500 – $420 – $110 – $330 = $1,940). Note that the amount the family spends on food is not part of the calculation. 15. C. If a VA borrower has residual income at least 20% over the required minimum, the lender may approve the application without other compensating factors even if the borrower exceeds the 41% income ratio.