Collection Policy in Veteran Loan Defaults Criticized

The Department of Veterans Affairs spends millions of dollars each year trying to collect some of the $2 billion owed by veterans who have lost their homes through foreclosures, but retrieves only a fraction of the amount, according to the General Accounting Office and veterans organizations.

GAO investigators found that the department’s emphasis on foreclosing after a veteran defaults on a mortgage, and then trying to get cash from the veteran, is a “flawed” policy that has resulted in collection of only about 14% of the total debt, said Ed Kratzer, the GAO’s deputy assistant director for housing. The GAO, which is the investigative agency of Congress, is working on two reports about loan policies and practices at the veterans department.

Several years of high foreclosure rates, especially in the Southwest and West, have seriously depleted the fund used to guarantee veterans’ mortgages, forcing Congress to appropriate $1.7 billion since 1984 to keep the program afloat.

More than 13 million military families and individuals have bought homes over the last 45 years with the help of the loan guaranty revolving fund. The fund is used to pay lenders when veterans default on their mortgages. Under the present system, the government guarantees mortgages for up to 50% of a loan of $45,000 or less. If a loan is higher than $45,000, the department guarantees 40% of the total or $36,000, whichever is less.

While spending money and effort to collect the debt, the veterans department frequently ignores other ways of handling a default that would be less costly to veterans and to the government, Kratzer said.

“Foreclosure is usually the most expensive” way to handle a loan default and it is a “messy, expensive” process, he said.

After a foreclosure, the department sells the house. If the proceeds of the sale are less than the amount owed on the mortgage, the department tries to collect the difference from the veteran. Few veterans, who presumably would not have defaulted in the first place if they had had enough money, have sufficient funds to pay this extra amount, veterans’ groups said.

One GAO report nearing completion is expected to “point out alternatives to foreclosure that (the veterans department) ought to be considering,” Kratzer said. “There is a lot of money to be saved on both sides,” by veterans and the government, he said.

The department could, for example, ask a veteran to deed his home voluntarily to the government, saving the cost of a foreclosure, or the agency could pay off the loan and become, in effect, the veteran’s banker. If the government takes over the loan, it usually restructures it and may lower the payments.

Taking over a loan is the best solution because it keeps veterans in their homes, according to Charles M. Novak, management analyst with the GAO’s Seattle regional office. “There’s only about a 50% success rate (with this tactic), but even if it only works half the time, it’s still beneficial” for the veterans department because it saves foreclosure costs on half the houses the department takes over, he said.

The third alternative to foreclosure is called a compromise sale, in which the veteran is allowed to sell his home when he can no longer make payments. If the proceeds of the sale are not enough to cover the amount due, the government advances the money needed to make up the difference and asks the veteran to sign a promissory note to pay all or part of the amount.

Novak, who studied veterans department foreclosures in several regions of the country, said the government chose an alternative to foreclosure in only a small number of mortgage-default cases.

In Seattle, for instance, he said it costs the government about $11,000 in interest, maintenance, tax and other expenses to hold a house for a year after foreclosure. The veterans department collects an average of $3,000 from the veterans after foreclosure, meaning that the government “is spending $11,000 to collect $3,000,” he said.

Congress and the Bush Administration have sharply different views of what to do about the troubled veterans’ loan fund.

A bill approved recently by the House Committee on Veterans Affairs would indemnify veterans, barring the government, in all but a few cases, from trying to collect from those who have lost their homes.

The legislation would abolish the current loan guaranty fund and replace it with a mortgage insurance program for veterans.

To help support the fund, veterans would pay a fee of 1.5% of the total loan amount or three-fourths of 1% if the veteran makes a down payment of 5% or more. The government would pay one-fourth of 1% of the loan amount each year for three years to help fund the insurance program. Disabled veterans and widows of veterans who died from service-connected causes would not have to pay the fees.

Veterans currently pay 1% of their mortgage amounts into the revolving loan fund.

The Congressional Budget Office said that income from fees and proceeds from loan sales would enable the new insurance fund to build up a reserve that could be invested in U.S. Treasury securities.

Eliminating veterans’ obligations to repay the government after a foreclosure would have little impact on the new mortgage fund because the veterans department collects so little of the debt, the budget office said.

The Bush Administration, however, believes that the proposed fund would show deficits beginning in 1994 that would continue indefinitely, said R.J. Vogel, chief benefits director for the veterans department.