DEPARTMENT OF

VETERANS AFFAIRS

Credit Costs and

Risks of Proposed VA

Small Business Loan

Guarantee Program

United States General Accounting Office

GAO Report to Congressional Requesters

June 2000

GAO/GGD-00-158

United States General Accounting Office General Government Division

Washington, D.C. 20548

Page 1 GAO/GGD-00-158 VA Credit Cost and Risk

B-284255

June 30, 2000

Congressional Requesters

This report responds to a mandate in the Veterans Entrepreneurship and

Small Business Development Act of 1999 that we analyze the federal costs

and risks of a proposed program for the Department of Veterans Affairs

(VA) to guarantee small business loans to veterans for the acquisition of

fixed assets used in a business. As agreed with your offices, our objectives

were to analyze (1) the federal credit costs and risks of the proposed

program, (2) the cost impact of alternative borrower requirements in the

implementation of the proposed program, and (3) the administrative issues

resulting from VA’s implementation of the proposed program.

To address the federal credit costs and risks of the proposed program, we

reviewed the credit costs, risks, and program features of the Small

Business Administration’s (SBA) 7(a) and 504 loan guarantee programs to

provide financial benchmarks. SBA’s 7(a) program is intended to help

small business borrowers who cannot otherwise obtain credit under

suitable terms and conditions from the private sector to start or expand a

business. SBA’s 504 program provides long-term, fixed asset financing

through certified development companies to new and existing small

businesses to contribute toward economic development.

The federal credit costs and risks of the proposed program could be

similar to SBA’s 7(a) or 504 loan guarantee programs, depending on which

program it most resembled. A proposed VA program designed like SBA’s

7(a) program could require a similar federal credit subsidy because fees

collected from program participants likely would not cover federal

guarantee payments. Based on SBA’s most recent estimates, the credit

subsidy rates for the 7(a) program for fiscal years 1992 through 1999 have

been under 2 percent. Alternatively, if the proposed program were

designed like SBA’s 504 program, its credit subsidy rate would be harder to

predict. SBA’s most recent estimates showed the credit subsidy rates were

around 4 or 5 percent for fiscal years 1992 through 1996. Fees charged to

504 program participants were increased in 1996, and the program has not

required a federal subsidy since 1997. Based on historical patterns of the

504 program, it is uncertain whether a federal subsidy will be required in

the future.

Results in Brief
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Based on historic experience and the design of the program, including the

differing fee structures, the subsidy rate for SBA’s 7(a) program is

generally expected to be higher than for SBA’s 504 program. Our analysis

of veteran loan performance indicated that credit costs resulting from

borrower defaults on loan payments would be about the same for veterans

who could participate in the proposed VA program, as compared with

borrowers who participate in the benchmark SBA programs. An economic

downturn or other events could increase the proposed program’s federal

credit costs.

Alternative borrower requirements, such as requiring personal equity as a

down payment, have the potential to lower credit costs. We were not able

to quantify the impacts of alternative borrower requirements on federal

credit costs of the proposed program because SBA does not generally

maintain these data for the benchmark programs. In any case, more

stringent borrower requirements could make the program less attractive to

possible program participants.

VA’s lack of experience in administering a small business loan guarantee

program could create administrative challenges and may lead to higher

administrative costs than the benchmark SBA programs. VA officials said

that while they have the expertise to adequately evaluate mortgage

applications, they do not have the knowledge and human capital resources

to adequately evaluate business loan applications. In February 2000, VA,

SBA, and the Association of Small Business Development Centers entered

into a Memorandum of Understanding to share expertise with the intent to

expand small business opportunities for veterans. Veteran service

organization officials said that they would like to see SBA place greater

emphasis on providing entrepreneurial outreach assistance to veterans

than on the implementation of a new business loan guarantee program.

In this report, we have a matter for congressional consideration addressing

expertise sharing between VA and SBA as an alternative to a new program

in VA at this time. To take advantage of existing resources and

administrative infrastructures, it may be more cost effective to use the

current expertise of VA and SBA to expand SBA guaranteed business loan

opportunities to veterans. SBA and VA provided technical comments,

which were incorporated where appropriate. VA agreed with our

conclusions.

The federal government provides guarantees on loans as a mechanism to

achieve numerous objectives, such as assistance for home ownership and

small business opportunities. Federal guaranteed loan programs generally

Background
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receive a federal credit subsidy, which equals the estimated present value

of net costs to guarantee loans made from an appropriation for the specific

fiscal year over the time the loans are outstanding. Each fiscal year, federal

agencies offering loan guarantee programs are to calculate the subsidy

costs of these programs for budget and financial reporting purposes.

Federal agencies operating loan guarantee programs are required to

submit annual re-estimates of subsidy rates for loans guaranteed in fiscal

year 1992 and forward. These re-estimates are to adjust the original

subsidy rate estimates based on actual loan performance. These reestimates thus reflect the amount of credit subsidy required from or

returned to the U.S. Treasury.

SBA operates loan guarantee programs that provide financial assistance to

small businesses. SBA’s 7(a) program is its largest loan guarantee program

and primary vehicle for providing borrowers with access to financing for

small businesses. The 7(a) program is intended to serve borrowers who

could not otherwise obtain credit under suitable terms and conditions

from the private sector. In the 7(a) program, SBA guarantees up to 80

percent on loans made by participating private sector lenders. This

guarantee provides lenders partial protection against loan losses when

payments are not made. SBA’s 504 program provides long-term, fixed asset

financing through certified development companies. These corporations

are sponsored by private-sector organizations or by state or local

governments to contribute to local economic development.

A typical 504 loan requires borrowers to provide at least 10 percent of the

project’s financing, 50 percent financing from a private-sector lender, and

the remaining share from the sale of debentures guaranteed by the SBA.

The dollar volume of 7(a) and 504 loans that SBA can guarantee each year

is based on congressional appropriations. SBA guaranteed about $9 billion

in 7(a) loans annually in fiscal years 1997 through 1999. SBA guaranteed

slightly more than $1 billion in 504 loans annually in fiscal years 1997 and

1998. For fiscal year 1999, SBA guaranteed $700 million, as of February 29,

2000.1

 Veterans received about 15 percent of 7(a) loans and about 7

percent of 504 loans, between fiscal years 1992 and 1999. More detailed

information on these programs is presented in appendix I.

VA operates an entitlement program that provides single-family, residential

mortgage loan guarantees for eligible veterans to purchase, construct,

repair, or refinance homes.

 

1

 We relied on SBA data on loan disbursements, rather than loan approvals. Loan approvals in fiscal

year 1999 equaled about $2 billion.
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VA provides private-sector mortgage lenders with a partial guarantee on

mortgage loans when loans go into foreclosure. In exchange for the

guarantee, VA encourages lenders to offer loans to veterans on terms more

favorable than conventional financing, such as requiring small or no down

payment. In fiscal year 1999, VA provided loan guarantees on 486,000

mortgage loans with a principal balance of $54 billion. The average loan

size was about $110,000. VA officials stated that fiscal year 1999 was one

of the highest levels of loan guarantee activity in the program’s history, as

a result of interest rate decreases that led to an increased level of

refinancing activity. Because the VA guaranteed mortgage loan program is

an entitlement program, Congress provides VA with a supplemental

appropriation when the guaranteed amount exceeds the initial

appropriation. More detailed information on this program is presented in

appendix I.

The initial authority for VA to provide guarantees for small business loans

was made shortly after World War II. In 1974, Congress repealed VA’s

business loan guarantee authority due to the decreased level of

participation. In 1981, VA was authorized to provide loan guarantees for

small business loans made to Vietnam era or disabled veterans. This loan

guarantee authority expired on September 30, 1986. According to VA

officials, this small business loan guarantee program was not implemented

because Congress did not provide federal appropriations. VA officials

stated that annual appropriations were provided to SBA to guarantee loans

to veterans because that agency had greater expertise in business loan

matters. VA currently refers veterans to SBA for business loan matters.

The Veterans Entrepreneurship and Small Business Development Act of

1999 mandated that we analyze the anticipated federal costs and risks of a

proposed fixed-asset small business loan guarantee program for veterans.

We were to assume that up to 10 percent of funds appropriated for the VA

guaranteed residential mortgage loan program would be made available for

a small business loan guarantee program within VA. We treated this

amount as an additional cost and risk to the federal government because

the funds appropriated for the VA mortgage loan program cannot be

reduced to serve other purposes. Therefore, the government may need to

provide an appropriation for the proposed program. We also assumed that

the proposed program could take on the design of either SBA’s 7(a) or 504

loan guarantee programs. By design, we mean that the proposed program

could have similar loan products, terms, underwriting standards, and

standard operating procedures as the benchmark programs. Similar to the

experience of the 7(a) and 504 programs, the credit costs of the proposed

program would be affected by changes in economic conditions.

Scope and

Methodology
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To help us estimate federal credit costs and risks of the proposed program,

we analyzed SBA’s 7(a) General Business Guarantee and 504 Certified

Development Company loan programs to provide financial benchmarks.

We interviewed SBA officials and reviewed SBA information on the

administration of the benchmark programs, which included data on fees,

SBA standard operating procedures, and program loan performance. We

analyzed the benchmark programs’ costs and other financial data

presented in the fiscal years 1999 through 2001 Budget of the United States

Government and the corresponding Federal Credit Supplement: Fiscal

Year 2001. We referred to the credit subsidy re-estimates contained in the

latter document as fiscal year 2001 re-estimates. Our analysis included

consideration of possible differences between federal credit costs of the

proposed program and the benchmark SBA programs based on different

features of the programs and the small business borrowers served.

To analyze how federal credit costs and risks of the proposed program

could be affected by alternative borrower requirements, we reviewed

SBA’s underwriting requirements.2

 We discussed with SBA officials their

independent contractor study of 7(a) and 504 loan programs.3

 We also

reviewed the loan performance of veterans and all borrowers who

obtained SBA 7(a) and 504 loans. We also analyzed loan performance of

veterans participating in VA’s residential mortgage loan guarantee program

and the participants in the Federal Housing Administration’s (FHA) Mutual

Mortgage Insurance Program. Appendix II contains our analysis of VA and

FHA loan performance. We also reviewed reports on the performance of

SBA 7(a) loans from Moody’s Investor Services and Standard & Poors and

discussed 7(a) loan performance with an official from Moody’s.

To identify potential administrative issues resulting from implementation

of the proposed program by VA, we interviewed VA officials and reviewed

VA’s information on its guaranteed residential mortgage loan program. We

also met with veteran service organization officials from the Disabled

American Veterans, Veterans of Foreign Wars, and Vietnam Veterans of

America to obtain their perspectives of the proposed program within VA.

We did not report confidential SBA data specific to veterans’ loan

performance. We relied on SBA data on costs and loan performance as

 

2

 Underwriting standards are used to determine which loans are made. Underwriting is the process of

identifying the potential risks of loss associated with financial activities to determine loan eligibility,

interest rate, and other factors.

3

 Walker & Company, Independent Study of 7(a) and 504 Loan Programs for the Eleven Cohort Years

Ended September 30, 1996 (June 16, 1997).
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reported to us by SBA. SBA loan performance and credit cost information

is reviewed as part of the annual financial statement audits. SBA received

an unqualified opinion on its fiscal year 1999 financial statements. We also

relied on VA data on annual mortgage loan guarantee amounts and loan

performance as reported to us by VA.

We conducted our work in Washington, D.C., between September 1999 and

May 2000 in accordance with generally accepted government auditing

standards. We requested comments on a draft of this report from the

Administrator, SBA, and Secretary of VA. SBA’s and VA’s written

comments are discussed near the end of this letter and are reprinted in

appendixes III and IV, respectively.

The federal credit costs and risks of the proposed program could be

similar to SBA’s 7(a) or 504 loan guarantee programs, depending on which

program it most resembled.4

 The design of the proposed program will

determine the level of federal subsidy, if any, necessary to support the

program. The proposed program likely would require a subsidy if designed

like the 7(a) program. However, based on historical data, the proposed

program with an SBA 504 design may or may not require a credit subsidy.

According to our analysis of SBA data, veteran loan performance in the

SBA programs was generally similar to the loan performance of the total

loan portfolio for each program.

SBA’s 7(a) program has required federal subsidies. As shown in table 1,

SBA’s original subsidy rate estimates for the 7(a) program ranged from

about 1 percent to about 5 percent for fiscal years 1992 through 2001.

SBA’s fiscal year 2001 re-estimates of credit costs showed that the 7(a)

program required a federal subsidy of less than 2 percent for fiscal years

1992 through 1999.

 

4

 The cost to the federal government of extending or guaranteeing credit is called the subsidy cost.

This cost is defined as the estimated long-term cost to the government, calculated on a net present

value basis. It excludes administrative costs and any incidental effects on government receipts or

outlays. For loan guarantees, the subsidy cost is the present value of cash flows from estimated

payments by the government (for defaults and delinquencies, interest rate subsidies, and other

payments) minus expected payments to the government (for loan origination and other fees, penalties,

and other recoveries).

Credit Costs and Risks

of Proposed Program

Would Depend on

Proposed Program’s

Design

SBA’s 7(a) Program Has

Required Federal Subsidies
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Subsidy rate (percent)a

7(a) 504

Fiscal year Original

Fiscal Year

2001

Re-estimate Original

Fiscal Year

2001

Re-estimate

1992 4.85 1.81 0.49 4.96

1993 5.21 1.14 0.54 3.59

1994 2.15 0.82 0.51 5.05

1995 2.74 1.76 0.57 4.20

1996 1.06 0.34 0.00 3.59

1997 1.93 0.02 0.00 -2.71

1998 2.14 0.88 0.00 -1.63

1999 1.39 1.03 0.00 -1.12

2000 1.16 N/A 0.00 N/A

2001 1.24 N/A 0.00 N/A

Note: N/A represents no data available.

a

The subsidy rate is the credit subsidy received by the program expressed as a percent of the total

dollars loaned through the program. It is calculated separately for loans made from the appropriations

for the specific fiscal year, called the fiscal year loan cohort. The figures shown in the columns labeled

“original” are the estimated subsidy rates calculated for budget purposes prior to the fiscal years. A

re-estimate of the subsidy rate is made in each subsequent fiscal year that loans from the cohort are

outstanding. A negative rate means that funds are returned to the U.S. Treasury.

Source: Federal Credit Supplement to the Fiscal Year 2001 U.S. Budget.

SBA’s 504 program has not required a federal credit subsidy since 1997, but

it did require a subsidy for prior fiscal years. As shown in table 1, SBA’s

original subsidy rate estimates for the 504 program were less than 1

percent for fiscal years 1992 through 1995. SBA’s fiscal year 2001 credit

subsidy rate re-estimates showed that the program required a federal

subsidy around 4 or 5 percent for fiscal years 1992 through 1996. The 504

program experienced higher than expected credit costs for lending activity

from appropriations for fiscal years 1992 through 1996.

For fiscal year 1996 and forward, SBA original subsidy rate estimates

showed that the 504 loan program would require a zero credit subsidy.

The zero subsidy is required by federal statute. As a result of the zero

subsidy requirement, SBA increased the fees charged to borrowers and

lenders.5

 SBA’s fiscal year 2001 re-estimates showed negative subsidy

rates for fiscal years 1997 through 1999. For these fiscal years, the 504

program is now estimated to collect more in fees than paid out in default

payments.

 

5

 The Small Business Investment Act of 1958, as amended, requires SBA to charge additional fees to

offset the subsidy costs of the 504 program. SBA is to annually charge certified development

companies a participation fee and development company fee. These additional fees became effective

October 1, 1996.

Table 1: SBA 7(a) and 504 Subsidy

Rates for Fiscal Year 1992-2001 Loans

SBA’s 504 Program Has Not

Required a Federal Subsidy

in Recent Years
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For our analysis of federal credit costs and risk, we used credit subsidy reestimates because they reflect the actual performance of guaranteed loans

up to the date of the re-estimates.6

 Federal agencies’ credit subsidy reestimates are generally different from initial estimates. For example,

actual defaults can differ from initial expectations due to unanticipated

events, such as major changes in economic conditions that can affect

business performance and the borrowers’ ability to repay loans. Generally,

defaults on guaranteed small business loans increase during economic

downturns. When defaults are greater than expected, guarantee program

payments and federal credit costs are also greater than expected.

Based on our analysis of SBA loan performance data, veteran loan

performance was generally similar to the loan performance of the total

loan portfolio for each program. Tables 2 and 3 show the percent of 7(a)

and 504 loans guaranteed in fiscal years 1990 through 1999 that were either

current in payment or paid in full, as of February 29, 2000. We calculated

that an average of 87 percent of all 7(a) loans and an average of 96 percent

of all 504 loans were either current or paid in full. Veteran loan

performance was generally consistent with these averages for both

benchmark programs.7

Fiscal year

Total number of 7(a)

loans guaranteed

Percent of 7(a) loans

current

or paid in full

1990 15,832 81.3%

1991 16,511 85.0

1992 21,357 87.9

1993 23,553 88.3

1994 32,270 86.1

1995 48,673 83.3

1996 39,577 83.9

1997 38,301 86.9

1998 34,979 90.7

1999 33,267 96.0

Note: Data as of February 29, 2000.

Source: SBA.

 

6

 SBA officials told us that SBA’s methods and data used to construct the initial subsidy rate estimates

have improved over time.

7

 To provide further perspective on loan performance of veterans and all borrower participants, we

compared the loan performance of veterans participating in VA’s residential mortgage loan guarantee

program to that of participants in FHA’s Mutual Mortgage Insurance Program. The results are

consistent with our findings for veteran loan performance in the benchmark SBA programs. Our

analysis is presented in appendix II.

Subsidy Rate Re-estimates

Provide Better Measures of

Credit Subsidy Costs Than

Initial Subsidy Rate

Estimates

Veteran Loan Performance

in SBA Loan Programs Has

Been Generally Similar to

All Participants

Table 2: Percent of 7(a) Loans Current

or Paid in Full for Fiscal Year 1990-1999

Loans
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Fiscal year

Total number of 504 loans

guaranteed

Percent of 504 loans

current or paid in full

1990 1,378 99.2 %

1991 1,346 98.7

1992 1,826 97.0

1993 2,199 97.5

1994 3,321 93.9

1995 3,803 83.9

1996 5,855 96.7

1997 3,413 98.1

1998 3,680 93.8

1999 2,040 96.2

Note: Data as of February 29, 2000.

Source: SBA.

Because veteran loan performance in the benchmark SBA programs has

been generally similar to the loan performance of all program participants,

the proposed program could have credit costs that are similar to

whichever benchmark program it most closely resembled. The design of

the proposed program would greatly affect credit costs or the level of

federal subsidy needed, if any. If the proposed program were designed like

the 7(a) program, it would be more likely to require a federal subsidy. If

the proposed program instead were designed like the 504 program, it

would be less likely to require a federal subsidy.

Because SBA statistics were limited, we were not able to quantify the

potential impact that alternative borrower requirements, such as requiring

personal equity as a source of down payment, could have on the proposed

federal credit costs, including program participation and loan

performance. Alternative borrower requirements would appear to have

the potential to affect credit costs by affecting loan performance and

program participation by affecting the attractiveness of the program.

Veteran participation in SBA’s 504 program has been less than veteran

participation in SBA’s 7(a) program. Veteran participation in SBA’s 504

program brings into question whether the proposed program with a 504-

type design would result in lower veteran participation than needed to

utilize the $3 to $5 billion annually.8

 VA could provide inducements to

 

8

 The Veterans Entrepreneurship and Small Business Development Act of 1999 specifies that the

proposed program would allow an amount equal to up to 10 percent of the annual appropriation for the

guarantees provided by VA for residential mortgage loans. For fiscal years 1994 through 1999, VAguaranteed mortgage loans have ranged from $25 billion to $55 billion annually.

Table 3: Percent of 504 Loans Current

or Paid in Full for Fiscal Year 1990-1999

Loans

Proposed Program Could

Have Credit Costs Similar to

the Benchmark SBA

Program It Most Resembled

The Impact of

Alternative Borrower

Requirements on

Credit Costs Is Unclear
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attract greater veteran participation, but such actions likely would

generate additional federal credit costs.

SBA does not generally maintain readily available data that could be used

to determine if down payments (i.e., equity contribution) affect loan

performance or program participation. Instead, SBA officials said that

they analyze business loan performance by concentrating on cash flows

and information on the borrower and the business. An official from

Moody’s that we interviewed, who analyzes SBA 7(a) loan performance,

emphasized the difficulty associated with measuring such variables as the

loan-to-value ratio on business loans consistently across loan pools. He

stated that lenders do not have consistent methodologies for constructing

loan-to-value ratios. In addition, since the financial and business skills of

the small business operator have a major impact on business success and

subsequently loan performance, collecting data on the relationship

between borrower down payments and loan performance may be of

limited use.

Due to the absence of SBA data that could be used to determine if there is

a relationship between down payments and SBA loan performance or

program participation, we were unable to determine how down payment

requirements would affect credit costs of the proposed VA small business

loan guarantee program. Although SBA’s 504 program requires a down

payment of 10 percent, we could not determine whether this down

payment requirement affected loan performance due to the absence of

data.

In addition to increasing down payments, VA could impose other more

stringent borrower requirements to reduce federal credit costs of the

proposed program. For example, VA could be given the authority to

require borrowers to provide fixed-asset business property, such as real

estate or personal financial assets, as collateral. In addition, VA could

establish standards that limit the number of years the borrower has for

repayment of a fixed-asset business loan or implement high program fees

paid by borrowers. While these actions might reduce federal credit costs,

such actions also likely would reduce program participation, especially if

veterans have access to alternative, more attractive sources of small

business loans. For example, veterans may choose to participate in either

SBA’s 7(a) or 504 programs, if the proposed program had more stringent

borrower requirements, such as shortened repayment terms. Furthermore,

if VA imposed stringent requirements, veteran borrowers may seek

unguaranteed, or conventional small business loans from financial

institutions.

Relevant Statistics Are Not

Readily Available to

Evaluate the Impact on

Credit Costs

More Stringent Borrower

Requirements Could

Reduce Credit Costs and

Program Participation
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VA might also reduce federal credit costs by requiring lenders to pay high

fees or offering a low loan guarantee percentage. These actions, directed

at lenders, also have the potential to reduce program participation. Such

actions may lead lenders to limit or eliminate use of the VA program or

charge small business borrowers higher interest rates to cover credit risk

exposure or any additional lender fees charged by VA.

Veteran participation has been greater in SBA’s 7(a) program than in SBA’s

504 program in terms of both dollar volume of loans guaranteed and the

percentage of overall participation in both programs. As shown in table 4,

during fiscal years 1992 through 1999, veterans received 12 to 16 percent of

SBA 7(a) and 5 to 9 percent of SBA 504 loan dollars. Total annual dollar

volume for veterans has been below $1.4 billion for SBA 7(a) loans and

below $200 million for SBA 504 loans. Officials from veteran service

organizations that we interviewed did not specifically endorse either SBA’s

7(a) or 504 program as a preferred design for the proposed program. They

emphasized that SBA’s role in guaranteeing business loans to veterans

could be expanded by SBA’s increasing entrepreneurial assistance

outreach efforts to veterans. This emphasis appears to center on the

business opportunities provided by SBA’s 7(a) program more so than

SBA’s 504 program because entrepreneurial assistance can be more

valuable for the start-up, less established small businesses that SBA’s 7(a)

program is intended to serve.

7(a) 504

Fiscal year

Loans to

veterans

Percent of all

loans

Loans to

veterans

Percent of all

loans

1992 $868.9 15 $35.1 5

1993 995.2 15 41.3 5

1994 1,306.1 15 84.9 6

1995 1,294.2 16 94.3 6

1996 1,191.7 15 172.9 7

1997 1,391.0 15 109.9 8

1998 1,226.7 14 144.4 8

1999 1,198.1 12 181.9 9

Note: Dollar amounts and percentages of loans are based on gross amounts of initial loan approvals.

Source: SBA.

Veteran Participation in

SBA’s 7(a) Program Has

Been Greater Than Veteran

Participation in SBA’s 504

Program

Table 4: SBA 7(a) and 504 Loans to

Veterans, Fiscal Years 1992-1999

(Dollars in millions)
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As shown in table 4, veterans have annually accounted for less than $1.4

billion in 7(a) loans and less than $200 million in 504 loans. The proposed

program could provide about $3 to $5 billion annually in guaranteed small

business loans. Thus, the proposed program could represent a large

expansion in guaranteed small business loans to veterans in relation to

veteran participation in SBA’s 7(a) program and especially in relation to

SBA’s 504 program. Therefore, if VA were to implement the proposed

program, there could be incentives to establish low program standards to

expand guaranteed loans to veterans. For example, VA may relax business

plan standards used in the evaluation of the business loan application

package. Such actions could increase the credit costs of the proposed

program.

Thus, more stringent borrower requirements would appear to have the

potential to improve loan performance and lower credit costs; they also

could make the program less attractive to participants. Conversely, less

stringent borrower requirements could make the program more attractive

to participants, but increase credit costs if there were a decline in loan

performance.

VA’s lack of experience in administering a small business loan guarantee

program likely would create administrative challenges for the agency to

implement the proposed program. Further, the demand for a new, small

business loan guarantee program within VA, which could be similar to

existing SBA programs, is uncertain. VA likely would initially experience

higher administrative costs to implement the proposed program, in

comparison to the administrative costs associated with the benchmark

SBA programs. While VA has administrative infrastructure and human

capital resources that specialize in the review of mortgage loan

applications, it does not have similar resources that specialize in the

review of business loan applications or the servicing of business loans. VA

has access to information regarding veterans’ business concerns and a

network to facilitate outreach to veterans. VA and SBA have an agreement

to exchange expertise pertaining to business loan matters for veterans.

Based on current dollar volume of SBA loans to veterans in the 7(a) and

504 programs, it is uncertain if veteran participation in the proposed

program would be in the $3 billion or greater range. As shown in table 4,

veterans have accounted for less than $1.4 billion and less than $200

million annually in SBA’s 7(a) and 504 programs, respectively. Veteran

service organization officials said veteran participation in the current set

of SBA loan programs likely would increase if SBA were to undertake

The Proposed Program’s

Federal Credit Costs Could

Be Affected by Inducements

to Increase Veteran

Participation

VA Would Face

Administrative

Challenges in

Implementing the

Proposed Business

Loan Guarantee

Program

Veteran Demand for a Small

Business Loan Guarantee

Program Within VA Is

Uncertain
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better outreach efforts to ensure that veterans are provided the same

assistance and information as other group participants.

SBA’s Office of Veterans Affairs is to provide increased opportunities for

veteran-owned small businesses. This goal is to be achieved by expanding

small business procurement opportunities and enhancing entrepreneurial

development assistance for veterans. For example, SBA has initiated a

new veterans business outreach program, which is to provide business

training, counseling, technical assistance, and mentoring assistance to

service-disabled veteran entrepreneurs. The Office could provide a focal

point within SBA for coordinating with VA in outreach efforts and

information dissemination to veterans.

VA likely would have higher administrative costs per loan dollar to

implement the proposed program in relation to the benchmark SBA

programs, even if the proposed program’s funding was fully utilized.

According to SBA, the cost of making a 7(a) loan is about $1,000. The cost

of making a 504 loan is about $2,000. In addition, SBA incurs annual loan

servicing costs for the 7(a) and 504 loan programs. 9 VA likely would

initially incur higher costs to perform these same functions until it

developed the necessary expertise and program infrastructure.10 For

example, SBA has staff and monitoring systems in place to manage a

business loan guarantee program.

VA officials said that the agency does not have the human capital

resources to adequately evaluate business loan applications and service

small business loans. Officials said that VA would need to hire additional

staff, seek technical assistance from SBA, and develop an overall

infrastructure to perform the functions associated with a business loan

guarantee program.

 

9

 Loan servicing involves tasks performed by lenders while the loan is outstanding. Such tasks

generally include, among others, collecting and recording interest and principal payments; readjusting

loan terms, if necessary; and taking actions when borrower loan payments are delinquent. According

to SBA, loan servicing costs about $125 annually for a 7(a) loan and about $175 annually for a 504 loan.

10 VA and SBA delegate authority to lenders to approve and service loans. In this case, expertise

required to develop and implement requirements for lenders is similar to expertise required to approve

and service loans.

Administrative Costs Per

Loan Dollar Likely Would

Be Higher Initially In

Relation to the Benchmark

SBA Programs
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Page 14 GAO/GGD-00-158 VA Credit Cost and Risk

A review of business loan packages would require expertise in evaluating

business performance indicators that would reflect a reasonable

expectation of future business prosperity. In contrast, federally guaranteed

loan programs for single-family, residential mortgage loan applications

require review to ensure borrower credit worthiness and that adequate

collateral is present to obtain loan guarantee approval. VA officials said

that while the agency has expertise to adequately evaluate single-family

mortgage loan applications, it does not have the expertise to adequately

evaluate business loan application packages. Agency officials said that

they would have to seek expertise from SBA to determine the

administrative tasks associated with operating a small business loan

guarantee program. If VA were to operate the proposed program without

sufficient expertise to adequately evaluate business loan performance, the

federal government’s credit costs and risk exposure likely would increase.

SBA also has experience in servicing business loans, including loans with

delinquent payments. While the principal balances of SBA guaranteed

business loans generally are larger than VA-guaranteed residential

mortgage loans, business loans generally offer less marketable forms of

collateral than mortgage loans when delinquent loans default. SBA

officials said that SBA makes extensive attempts to keep the borrower in

business when loan payments are delinquent. For example, SBA may offer

interest rate restructuring to allow the borrower to become current in

payment or allow loan payment deferments. 11 According to SBA, for fiscal

years 1990 through 1999, of the delinquent 7(a) loans that were purchased

by SBA from lenders to fulfill SBA’s guarantee commitments, about onethird were cured—returned to current payment or placed in deferment

status.

Curing delinquent small business loans is more difficult than curing

delinquent residential mortgage loans, as evidenced by a higher cure rate

for residential mortgage loans. SBA officials said that SBA has the intent

to keep the small business borrower in business when loan payments are

delinquent. Likewise, VA officials said that VA undertakes supplemental

servicing to keep the home borrower in possession of the borrower’s home

when mortgage loan payments are delinquent. However, the marketable

collateral and direct contribution to the borrower’s quality of life provided

by an owner-occupied home provides incentives for the borrower to bring

 

11 Deferment status results when SBA allows the borrower to defer, or delay, loan payments in return

for the borrower’s agreement to become current on payment obligations at an agreed upon future time.

VA’s Lack of Expertise in

Business Loan Matters

Could Make It Difficult to

Evaluate Small Business

Loan Applications

Servicing Small Business

Loans Is Different From

Servicing Residential

Mortgage Loans
B-284255

Page 15 GAO/GGD-00-158 VA Credit Cost and Risk

delinquent payments current and remain in the home.12 Therefore, cure

rates on delinquent VA-guaranteed residential mortgage loans are greater

than cure rates on SBA 7(a) loans. Cure rates on delinquent VA-guaranteed

residential mortgage loans have averaged over 80 percent.

Managing collateral on defaulted small business loans is also more difficult

than on defaulted residential mortgage loans, because owner-occupied

housing provides a better form of marketable collateral. Loss severity

rates—the percentage of outstanding loan principal that is lost when loans

default are higher with business loans. While SBA has not consistently

collected data on loss severity rates, a 1997 SBA-contracted study

suggested that SBA’s loss severity rates for the 7(a) and 504 programs are

in the 70 to 100 percent range. 13 14

Veteran service organization officials that we interviewed focused their

concerns on SBA’s outreach efforts aimed at veterans rather than the

creation of a new small business loan guarantee program within VA.

Several officials said that they would like to see SBA put greater emphasis

on providing entrepreneurial outreach and assistance to veterans. They

would like SBA to increase emphasis on providing veterans with

entrepreneurial assistance, such as business plan preparation. These

officials believe increased outreach efforts would make it easier for

veterans to obtain or expand their own businesses. Officials said they

believe that veteran participation in SBA’s programs likely would increase

with expanded outreach efforts.

 12 VA-guaranteed residential mortgage loan borrowers have other incentives to bring delinquent

mortgage loans current. If a VA borrower defaults, the borrower’s eligibility for a future VA-guaranteed

home mortgage loan can be reduced or eliminated. In our analysis, we assumed that if VA implemented

a small business loan guarantee program, a business default would not restrict the veteran’s eligibility

for a VA-guaranteed home mortgage loan.

13 Walker & Company, Independent Study of 7(a) and 504 Loan Programs for the Eleven Cohort Years

Ended September 30, 1996 (June 16, 1997).

14 An official at Moody’s, who analyzes 7(a) loan performance, said that loss rates on 7(a) loans backed

by real estate collateral have lower loss severity rates than 7(a) loans not backed by real estate.

Veteran Service

Organizations Seek Greater

Assistance From SBA to

Help Veterans in Small

Business Matters
B-284255

Page 16 GAO/GGD-00-158 VA Credit Cost and Risk

In February 2000, VA, SBA, and the Association of Small Business

Development Centers (ASBDC) entered into a Memorandum of

Understanding (MOU) to provide entrepreneurial assistance and support

to veterans through the small business development centers.15 The

purpose of the MOU is for VA and SBA to share collective expertise with

the intent to expand small business opportunities for veterans. The MOU

recognizes SBA’s and VA’s specific missions and their developed

administrative infrastructures that are needed to provide veterans with

business loan opportunities. For example, the MOU requires (1) VA to

compile a list of small business concerns owned and controlled by servicedisabled veterans that provide products or services that could be procured

by the U.S. government, (2) VA to provide facilities for entrepreneurial

training, and (3) SBA and ASBDC to provide training and information to

veterans on small business concerns. VA and SBA officials said the MOU

was needed to avoid duplicating efforts related to offering entrepreneurial

assistance to veterans.

The proposed business loan guarantee program within VA could have

similar credit costs and risks to SBA’s 7(a) or 504 business loan guarantee

programs, depending on which program it most resembled. More stringent

borrower requirements would appear to have the potential to reduce credit

costs; however, with the absence of data, we could not quantify any such

effects. Alternatively, less stringent requirements to induce veteran

participation in the proposed program, such as relaxing business plan

standards used in the loan application process could increase credit costs.

VA would face administrative challenges in implementing the proposed

program. The evaluation and servicing of business loans require different

skills, knowledge, and information than home mortgage loan servicing. VA

lacks the expertise and infrastructure to adequately evaluate and service

small business loans. For VA to implement the proposed program, it said it

would have to hire additional staff, seek SBA’s business loan expertise,

and develop an administrative infrastructure for a business loan guarantee

program. While VA has the infrastructure to reach veterans, SBA has the

expertise and infrastructure for operating business loan guarantee

programs. SBA and VA have entered into an MOU to share expertise with

the intent to expand small business opportunities for veterans.

Coordination between VA and SBA, such as enhanced training for veterans

 

15 This MOU was mandated by the Veterans Entrepreneurship and Small Business Development Act of

1999. ASBDC is a partnership program uniting private enterprise, government, higher education and

local nonprofit economic development organizations. ASBDC delivers educational and technical

assistance to small businesses regarding business management.

Agreement Provides for

SBA and VA to Exchange

Expertise on Business Loan

Matters for Veterans

Conclusions
B-284255

Page 17 GAO/GGD-00-158 VA Credit Cost and Risk

as required by the MOU, could further expand SBA’s business loan

opportunities for veterans.

This coordination initiative when fully implemented has the potential to

achieve many of the objectives of the proposed VA business loan program

by expanding veteran participation in SBA guaranteed loan programs.

Given the administrative challenges and costs VA would face in

establishing a new program and the initiatives currently under way

between VA and SBA, it may be prudent to defer consideration of a new

VA loan program. In addition, congressional committees with oversight of

veterans’ affairs and small business matters may want to encourage even

greater expertise sharing between VA and SBA that would take further

advantage of the small business loan opportunities offered by SBA to

provide business training and funding options for veteran-owned small

businesses. Furthermore, the committees may want to monitor closely

SBA’s outreach efforts aimed at veterans.

We requested comments on a draft of this report from the Honorable Aida

Alvarez, Administrator, Small Business Administration and the Honorable

Togo D. West, Jr., Secretary, Department of Veterans Affairs.

We received written comments on a draft of this report from SBA that are

reprinted in appendix III. SBA also provided technical comments, which

we have incorporated where appropriate.

We received written comments on a draft of this report from VA that are

reprinted in appendix IV. The letter stated that VA agrees with our

conclusions. In addition, VA provided technical comments, which we have

incorporated where appropriate.

We are sending copies of this report to the Honorable Aida Alvarez,

Administrator, Small Business Administration; the Honorable Togo D.

West, Jr., Secretary of Veterans Affairs; and other interested parties.

Copies also will be made available to others upon request.

Matters for

Congressional

Consideration

Agency Comments
B-284255

Page 18 GAO/GGD-00-158 VA Credit Cost and Risk

Please contact me or Bill Shear at (202) 512-8678 if you or your staff have

any questions. Major contributors to this report are listed in appendix V.

Sincerely yours,

Thomas J. McCool

Director, Financial Institutions

and Markets Issues
B-284255

Page 19 GAO/GGD-00-158 VA Credit Cost and Risk

List of Requesters

The Honorable Arlen Specter

Chairman

The Honorable John D. Rockefeller IV

Ranking Minority Member

Committee on Veterans’ Affairs

The Honorable Christopher Bond

Chairman

The Honorable John F. Kerry

Ranking Minority Member

Committee on Small Business

United States Senate

The Honorable Bob Stump

Chairman

The Honorable Lane Evans

Ranking Minority Member

Committee on Veterans’ Affairs

The Honorable James M. Talent

Chairman

The Honorable Nydia M. Velazquez

Ranking Minority Member

Committee on Small Business

House of Representatives
Page 20 GAO/GGD-00-158 VA Credit Cost and Risk

Contents

1 Letter

22

General Description of SBA 7(a) Loan Program 22

General Description of the 504 Loan Program 24

General Description of the Department of Veterans

Affairs Guaranteed, Single-Family Mortgage Loan

Program

25

Appendix I

Background

Information on SBA

and VA Loan Programs

and Loan

Requirements

28

General Description of the FHA Mortgage Insurance

Program

28 Appendix II

Loan Performance Is

Similar for VA and

FHA Fixed-Rate

Residential Mortgage

Loans

Appendix III 32

Comments From the

Small Business

Administration

Appendix IV 34

Comments From the

Department of

Veterans Affairs

Appendix V 35

GAO Contacts and

Staff

Acknowledgments
Contents

Page 21 GAO/GGD-00-158 VA Credit Cost and Risk

Table 1: SBA 7(a) and 504 Subsidy Rates for Fiscal Year

1992-2001 Loans

7

Table 2: Percent of 7(a) Loans Current or Paid in Full for

Fiscal Year 1990-1999 Loans

8

Table 3: Percent of 504 Loans Current or Paid in Full for

Fiscal Year 1990-1999 Loans

9

Table 4: SBA 7(a) and 504 Loans to Veterans, Fiscal

Years 1992-1999 (Dollars in millions)

11

Tables

Figure II.1: Percentage of Outstanding VA and FHA Loans

Delinquent 30 Days or More

30

Figure II.2: Percentage of Outstanding VA and FHA Loans

for Which Foreclosure Was Started During the Quarter

31

Figures

Abbreviations

ARM Adjustable Rate Mortgages

ASBDC Association of Small Business Development Center

CDC Certified Development Company

FHA Federal Housing Administration

Ginnie Mae Government National Mortgage Association

HUD Department of Housing and Urban Development

MBA Mortgage Bankers Association

MOU Memorandum of Understanding

SBA Small Business Administration

VA Department of Veterans Affairs
Appendix I

Background Information on SBA and VA Loan

Programs and Loan Requirements

Page 22 GAO/GGD-00-158 VA Credit Cost and Risk

This appendix provides background information on Small Business

Administration (SBA) 7(a) and 504 business loan guarantee programs and

on Department of Veterans Affairs (VA) guaranteed single-family

residential mortgage loan program.

The 7(a) loan guarantee program is SBA’s primary business loan program.

It provides guarantees for loans to small business owners unable to secure

financing under reasonable terms and conditions through conventional

lending channels. The 7(a) program operates through private-sector

lenders that provide loans that are, in turn, guaranteed by SBA. SBA does

not provide funds for direct lending or grants.

For most SBA loans, there is no legislated limit to the total amount of the

loan that may be requested from the lender. The maximum amount of an

SBA guarantee is generally $750,000. Thus, with a lender receiving an SBA

guarantee of 75 percent, the total loan amount available under this

program generally would be limited to $1 million. The proceeds of 7(a)

loans can be used for most business purposes. These may include the

purchase of real estate, machinery, inventory, and working capital.

Most small businesses are eligible for 7(a) loans. The Small Business Act

defines an eligible small business as one that is independently owned and

operated and not dominant in its field of operation. Financial assistance,

through 7(a) loans, is available for businesses that propose to be engaged

in business in the United States or its possessions and for those that

operate for profit. SBA determines eligibility based on type and size of

business, use of loan funds, and special circumstances. The cash flow of

the business is a primary consideration in the SBA loan decision process.

SBA also considers other factors, such as the loan applicant’s character,

management capability, collateral, and owners’ equity contribution. SBA

requires that all loan applicants that have a 20 percent or greater equity

share in the business personally guarantee SBA loans.

Prospective borrowers must take several steps to obtain a 7(a) small

business loan. For example, in SBA’s small business loan prequalification

program, prospective borrowers generally work with a technical

assistance organization, designated by SBA, to assist in the preparation of

business plans and completion of the loan prequalification application.

The technical organization reviews the applicant’s credit information,

performs a loan analysis, and submits the application to SBA. SBA reviews

the completed application to determine whether it meets the requirements

of a guaranteed loan and makes an approval or denied decision. If the

application is approved, SBA is to issue a prequalification letter stating the

General Description of

SBA 7(a) Loan

Program

Business and Loan

Applicant Eligibility
Appendix I

Background Information on SBA and VA Loan Programs and Loan Requirements

Page 23 GAO/GGD-00-158 VA Credit Cost and Risk

agency’s intent to authorize a guarantee on the loan. Applicants are

responsible for securing a lender interested in making the SBA-guaranteed

loan. In addition to this program, borrowers can obtain financing from

participating lenders—business lenders that have entered into lending

agreements with SBA to provide loans in conjunction with SBA

guarantees. Certified lenders are heavily involved in the regular SBA

guarantee loan processing and meet certain SBA criteria. Preferred

lenders have SBA’s full delegation of lending authority and can decide

unilaterally on SBA participation in eligible business loans.

SBA charges lenders a guarantee and a servicing fee for each loan

approved to offset the costs of the loan program to the taxpayer.

Guarantee fees can be passed on to the borrower after they have been paid

by the lender. The percent of the guarantee fee is determined by the

amount of the loan guarantee. When the guaranteed portion of the loan is

$80,000 or less, the guarantee fee will be 2 percent of the guaranteed

portion. Loans more than $80,000 but less than $250,000 are to have a 3

percent guarantee fee charged. For the next $250,000 of the guaranteed

portion, a 3.5 percent guarantee fee will be charged. For any loan portion

greater than $500,000, a 3.875 percent guarantee fee will be charged. In

addition, all loans will be subject to a fifty basis point (0.5 percent)

annualized servicing fee, which is applied to the outstanding balance of

SBA’s guaranteed portion of the loan.

Processing fees, origination fees, application fees, points, brokerage fees,

bonus points and other fees that could be charged to applicants are

prohibited.

Interest rates, which may be fixed or variable, are negotiated between the

borrower and the lender and are subject to SBA maximums. These

maximums are determined by the prime rate. Fixed-rate loans must not

exceed prime plus 2.25 percent if the maturity is less than 7 years or prime

plus 2.75 percent when loans mature in greater than 7 years. For loans of

less than $25,000, the maximum interest rate must not exceed prime plus

4.25 percent. For loans between $25,000 and $50,000, the maximum rate is

3.25 percent and 3.75 percent, respectively.

Variable-rate loans may be pegged to the lowest of either the prime rate or

SBA’s optional peg rate. The optional peg rate is a weighted average of

rates the federal government pays for loans with maturities similar to the

average SBA loan. The lender and the borrower negotiate the amount of

the spread, which can be added to the base rate. An adjustment period is

selected, which identifies the frequency at which the interest rate can

Fees, Interest Rates,

and Loan Maturities
Appendix I

Background Information on SBA and VA Loan Programs and Loan Requirements

Page 24 GAO/GGD-00-158 VA Credit Cost and Risk

change. It must be no more often than monthly and must be consistent,

such as monthly, quarterly, or semiannually.

SBA’s 504 Certified Development Company (CDC) program provides

growing businesses with long-term, fixed-rate financing for major fixed

assets, such as land and buildings. A CDC is a corporation set up to

contribute to the economic development of its community or region.

CDCs work with SBA and private-sector lenders to provide financing to

small businesses. There are about 290 CDCs nationwide.

Loan proceeds must be used for fixed asset projects, such as purchasing

land; improving existing buildings, grading, and streets; parking lots and

landscaping; construction of new facilities; or modernizing, renovating, or

converting existing facilities; or purchasing long-term machinery and

equipment.

A 504 project must have a loan secured with a senior lien from a privatesector lender covering up to 50 percent of the projects costs, a loan

secured with a junior lien from the CDC covering up to 40 percent of the

costs, and a contribution of at least 10 percent equity from the small

business being helped. SBA guarantees a debenture to finance the loan

secured with a junior lien from the CDC. The maximum SBA debenture

generally is $750,000 but can be up to $1 million, in some cases. The SBA

504 program is designed to enable small businesses to create and retain

jobs. The CDC portfolio must create or retain one job for every $35,000

provided by SBA.

Businesses eligible for a loan under the 504 program generally must be

operated for profit and fall within size standards set by SBA. Under the

504 program, businesses with a tangible net worth of less than $6 million

and average net income not in excess of $2 million after taxes for 2

preceding years are eligible to participate in the 504 program. Generally,

the project’s assets being financed are used as collateral. Business owners

must provide personal guarantees.

Loan fees total approximately 3 percent of the debenture and may be

financed with the loan. Interest rates on 504 loans are pegged to an

increment above the current market rate for 5-year and 10-year U.S.

Treasury issues. Loan maturities of 10 and 20 years are available.

General Description of

the 504 Loan Program

Business and Loan

Eligibility

Fees, Interest Rates,

and Terms
Appendix I

Background Information on SBA and VA Loan Programs and Loan Requirements

Page 25 GAO/GGD-00-158 VA Credit Cost and Risk

The principal objective of the VA-guaranteed, residential single-family

mortgage loan program is to allow eligible veterans—including members

of the selected reserves, active-duty service personnel, and spouses, an

opportunity to purchase, repair, or refinance homes for their own personal

occupancy. The program serves veterans and military personnel who may

not have the financial resources to qualify for conventional loans. The

program also encourages private lenders to extend favorable credit terms

to veterans for purchasing, constructing, or improving homes. The VA

loan guarantee program operates by substituting the federal government’s

guarantee for a down payment that would otherwise be required when a

veteran or reservist purchases a home. The VA guarantee helps protect

lenders against partial losses when loans default.

The VA guarantee program provides benefits to veterans and military

personnel, but it does not provide that a home is free of defects or that the

veteran is making a good investment, and it does not provide legal

services.

The actual guarantee amount per veteran depends on the loan amount and

whether the veteran had previously used the entitlement. VA will

guarantee up to 50 percent of the home mortgage loan with a maximum

guarantee amount not to exceed $36,000 per veteran or $50,750 for certain

loans over $144,000. VA will guarantee 50 percent of mortgage loans up to

$45,000; $22,500 for mortgage loans between $45,000 and $56,250; the

lesser of $36,000 or 40 percent for loans between $56,250 and $144,000; and

the lesser of $50,750 or 25 percent for loans greater than $144,000. VA can

make a maximum direct loan of $33,000 to certain severely disabled

veterans to acquire specialty adapted housing grants or $80,000 to Native

American veterans on trust land. Lenders will generally limit VAguaranteed mortgage loans to $203,000 due to secondary market

requirements. VA lenders generally issue mortgage-backed securities

(MBS) backed by cash flows from VA loans in the secondary mortgage

market. The MBS are guaranteed by the Government National Mortgage

Association (Ginnie Mae). Ginnie Mae is a government corporation within

the Department of Housing and Urban Development (HUD).

Veterans are considered eligible if they have meet certain service

requirements since 1940. The maximum entitlement per veteran is $36,000

or up to $50,750 for certain loans over $144,000. Veterans must apply to

VA to obtain a certificate of eligibility. This certificate shows the veteran’s

eligibility to receive the VA housing entitlement and indicates the amount

of guarantee that VA can provide. Veterans are responsible for selecting

their home and a lender that would honor the certificate of eligibility.

General Description

of the Department of

Veterans Affairs

Guaranteed,

Single-Family

Mortgage Loan

Program

Guarantee Rates

Veteran Eligibility

Requirements and Lender

Responsibilities
Appendix I

Background Information on SBA and VA Loan Programs and Loan Requirements

Page 26 GAO/GGD-00-158 VA Credit Cost and Risk

Lenders review the veterans’ credit information and request VA to assign a

licensed appraiser to determine the reasonable value for the property.

Some lenders can generally approve and automatically process veterans’

home mortgage applications when income and credit requirements are

met. Other lenders must submit the mortgage application to local VA

regional offices, which are to notify the lenders of their approval decision.

The law requires that VA be paid a funding fee for guaranteed loans. The

funding fee is paid by all but certain exempt veterans. All funding fees

must be paid to VA within 15 days of loan closing. The funding fees for

veterans who have not previously obtained a VA-guaranteed loan and

whose loan eligibility is not derived from 6 years of service in the Selected

Reserve is 2.0 percent of the loan amount for loans with down payments of

less than 5 percent. Veterans with at least a 5 percent down payment are

to pay a funding fee of 1. 5 percent of the loan amount. Veterans with at

least a 10 percent down payment are to pay a funding fee of 1.25 percent of

the loan amount.

The funding fee for eligible reservist personnel who have not previously

obtain a VA-guaranteed loan is about 0.75 percent higher for each down

payment category. Reservists are to pay a funding fee of 2.75 percent of

the loan amount for loans with down payments of less than 5 percent. A

funding fee of 2.25 percent of the loan amount is charged for loans with at

least a 5 percent down payment. A funding fee of 2.0 percent of the loan

amount is charged for loans with at least a 10 percent down payment.

The funding fee for subsequent use of the VA-guaranteed mortgage loan

program is higher. The fees for subsequent use are 3.0 percent of the loan

amount for loans with down payments of less than 5 percent. A fee of 1.5

percent of the loan amount (2.25 percent for reservists) for loans with at

least a 5 percent down payment. A fee of 1.25 percent of the loan amount

(2.0 percent for reservists) for loans with at least a 10 percent down

payment.

The funding fee for interest rate reduction refinancing loans is 0.5 percent.

Veterans using partial or restored entitlements for regular refinancing

loans will pay a 3 percent fee for subsequent use. Veterans who have not

previously obtained a VA loan will pay a 2 percent fee (2.75 percent for

reservists) as first time users in conjunction with regular refinancing loans.

Also, veterans are charged 1 percent of the loan amount for manufactured

homes.

Fees, Interest Rates,

and Terms
Appendix I

Background Information on SBA and VA Loan Programs and Loan Requirements

Page 27 GAO/GGD-00-158 VA Credit Cost and Risk

The interest rate of VA loans can be negotiated based on prevailing rates in

the mortgage market. The maximum home loan term is 30 years and 32

days. While VA has previously issued guarantees for adjustable-rate

mortgages, it currently only offers guarantees on fixed-rate residential

mortgage loans.
Appendix II

Loan Performance Is Similar for VA and FHA

Fixed-Rate Residential Mortgage Loans

Page 28 GAO/GGD-00-158 VA Credit Cost and Risk

In this report, we compared the loan performance of veterans with all

participants in SBA’s 7(a) and 504 programs. This appendix provides a

related comparison on residential mortgage loan performance. Veterans

participating in the VA-guaranteed, single-family mortgage loan program

are compared with participants in the Federal Housing Administration’s

(FHA) single-family mortgage insurance program. Although this

comparison may not be directly related to loan performance on federally

guaranteed small business loans, we include the comparison to provide

further perspective on the issue of veteran loan performance. A detailed

discussion of VA-guaranteed, residential single-family mortgage loan

program is in appendix I.

FHA is a government corporation within HUD. FHA insures mortgages

made by qualified lenders to persons to purchase or refinance homes. The

FHA mortgage insurance program helps borrowers by lowering some costs

associated with obtaining mortgage loans. FHA mortgage insurance

protects lenders against the risk of loan default. In the same manner as

VA-guaranteed loans, FHA-insured loans generally sell on the secondary

mortgage market in the form of MBS guaranteed by Ginnie Mae. FHA

loans are protected by FHA’s Mutual Mortgage Insurance Fund, which is

funded by borrower premiums.

The main advantage of FHA mortgage insurance is that the credit

qualifying criteria for borrowers are not as strict as conventional financing.

FHA generally allows potential homeowners to finance approximately 97

percent of the value of their home purchase through their mortgage. Thus,

borrowers can make a minimum 3 percent of the sales prices as a down

payment. In addition, FHA insurance also allows borrowers to finance

many closing costs; therefore, loan amounts can exceed 97 percent of

home value.

FHA insurance also limits some of the fees lenders may charge borrowers

for making the loans. The loan origination fee, charged by the lender for

the administrative cost of processing the loan, may not exceed 1 percent of

the mortgage amount. FHA sets limits on the dollar value of the mortgage

loan. According to HUD, as of January 1, 2000, FHA established mortgage

limits ranging from $121,296 to $219,849. Borrowers seeking mortgages

that exceed FHA loan limits can increase their down payment or finance

under a conventional mortgage. Borrowers pay an up-front insurance

premium at the time of purchase, which is generally added to the regular

mortgage payment.

General Description of

the FHA Mortgage

Insurance Program

Terms and Conditions of

FHA Mortgage Insurance

Program
Appendix II

Loan Performance Is Similar for VA and FHA Fixed-Rate Residential Mortgage Loans

Page 29 GAO/GGD-00-158 VA Credit Cost and Risk

While the VA program guarantees fixed-rate residential mortgage loans, up

to 30 percent of FHA-insured mortgages annually can be adjustable-rate

mortgages (ARM). ARMs insured by FHA have experienced higher loan

delinquency and foreclosure rates than FHA-insured, fixed-rate mortgages.

To cover some of HUD’s costs for FHA loans, HUD assesses home buyers

fees, such as up-front and annual renewal mortgage insurance fees. The

up-front fee for a 30-year loan is 2.25 percent of the loan amount (or 2.0

percent for a 15-year mortgage). This fee is charged to borrowers when

they close on the mortgage loan and can be included in the mortgage

payment. Borrowers purchasing a condominium are exempt from paying

the up-front mortgage insurance premium. Borrowers pay a 0.5 percent

annual renewal insurance premium. The mortgage insurance premium

collected from the borrower is to help defray costs associated with the

program.

The Mortgage Bankers Association (MBA) conducts the quarterly National

Delinquency Survey (the MBA Survey). The MBA Survey collects data from

over 180 lenders, including mortgage bankers, commercial banks, savings

banks, savings and loan associations, and life insurance companies. The

MBA Survey includes about 25 million mortgage loans on single-family

residential properties. We used data for fixed-rate VA and FHA residential

mortgage loans because VA guarantees fixed-rate mortgages. We collected

data on loans with borrower payments that were 30 days or more

delinquent and loans where foreclosure had been initiated. The MBA

Survey reports these measures as a percentage of loans outstanding during

each calendar year quarter.

VA and FHA loan delinquency rates and loan foreclosure rates are

presented in figures II.1 and II.2, respectively. Veteran performance in the

VA residential loan program appears to be fairly similar to loan

performance for borrowers in the FHA residential loan program. This

finding is consistent with veterans’ loan performance in SBA’s guaranteed

small business loan programs.

We also obtained loan performance data on VA-guaranteed and FHAinsured, fixed-rate residential mortgage loans included in Ginnie Mae

guaranteed MBS. These data indicated similar veteran loan performance in

the VA residential loan program and FHA fixed-rate mortgages.

In addition, we obtained loan performance data from VA that distinguished

between active duty borrowers and other veteran borrowers in the VAguarantee program. Active duty borrowers had slightly higher foreclosure

Fees

Loan Performance on

Fixed-Rate Mortgages Is

Similar for VA and FHA

Borrowers
Appendix II

Loan Performance Is Similar for VA and FHA Fixed-Rate Residential Mortgage Loans

Page 30 GAO/GGD-00-158 VA Credit Cost and Risk

rates than other veteran borrowers. However, based on our analysis, we

have concluded that excluding active duty borrowers would not affect our

findings based on comparing VA borrowers participating in VA’s guarantee

program and FHA borrowers participating in FHA’s insurance program.

Note: VA mortgage loans outstanding were predominately fixed-interest rate loans. (VA no longer

guarantees variable interest rate loans.) FHA guarantees both fixed and variable interest rate loans.

This graph shows all VA loans and only fixed-interest rate FHA loans.

Source: MBA.

Figure II.1: Percentage of Outstanding VA and FHA Loans Delinquent 30 Days or More
Appendix II

Loan Performance Is Similar for VA and FHA Fixed-Rate Residential Mortgage Loans

Page 31 GAO/GGD-00-158 VA Credit Cost and Risk

Note: VA mortgage loans outstanding were predominately fixed-interest rate loans. (VA no longer

guarantees variable interest rate loans.) FHA guarantees both fixed and variable interest rate loans.

This graph shows all VA loans and only fixed-interest rate FHA loans.

Source: MBA.

Figure II.2: Percentage of Outstanding VA and FHA Loans for Which Foreclosure Was Started During the Quarter
Appendix III

Comments From the Small Business

Administration

Page 32 GAO/GGD-00-158 VA Credit Cost and Risk
Appendix III

Comments From the Small Business Administration

Page 33 GAO/GGD-00-158 VA Credit Cost and Risk
Appendix IV

Comments From the Department of Veterans

Affairs

Page 34 GAO/GGD-00-158 VA Credit Cost and Risk
Appendix V

GAO Contacts and Staff Acknowledgments

Page 35 GAO/GGD-00-158 VA Credit Cost and Risk

Thomas J. McCool, (202) 512-8678

William B. Shear, (202) 512-4325

In addition to those named above, Joan M. Conway, Christine J. Kuduk,

and Sindy Udell made key contributions to this report.

GAO Contacts

Acknowledgments
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