By the Numbers

VA loans set the pace for housing turnover

Brian Landy, CFA | June 9, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The unprecedented increase in mortgage rates over the last year has left housing turnover as the dominant driver of prepayments. Earlier episodes dominated by turnover generally did not last long, so data on loan prepayments in this kind of setting barely existed prior to the last year. Loans insured by the Federal Housing Administration and the US Department of Veterans Affairs have typically turned over faster than conventional loans, and that stayed true last year. Even though conventional loans lagged FHA and VA, investors can still get a boost from borrowers with low credit scores. And VA loans turned over faster than FHA loans, something generally not true before pandemic.

Faster turnover in VA

VA loans have posted the fastest discount prepayment speeds over the last year (Exhibit 1). This shows speeds for 2% pools issued in 2020 and 2021, starting in mid-2021. Those pools were slightly out-of-the-money in the latter half of 2021, then rapidly moved deep out-of-the-money in 2022.  VA loans were persistently fastest across this time, followed by FHA loans. The gap between VA, FHA and conventional converged as mortgage rates increased in 2022. But VA stayed faster than FHA, which remained faster than conventional. The Rural Housing Service (RHS) loans started off the slowest but caught up to the FHA speeds in the latter part of 2022.

Exhibit 1. VA loans have posted the fastest discount prepayment speeds.

FHA/VA speeds exclude buyouts. Conventional loans have original LTV≤80 and original credit score≥700.
Source: Fannie Mae, Freddie Mac, Ginnie Mae, Santander US Capital Markets

Speeds on the government loans were especially fast in 2021, likely boosted by VA cash-out refinancing and FHA-to-conventional refinancing. FHA borrowers with significant appreciation can save money on mortgage insurance by refinancing into a conventional loan, even if the interest rate on the loan doesn’t change or increases slightly. And VA borrowers often get lower mortgage rates than other borrowers. The FHA and VA speeds include only voluntary prepayments and exclude buyouts, to make the comparison cleaner to conventional loans that had low buyout rates.

Faster turnover in smaller loans

FHA loans typically have smaller loan sizes than VA loans, which influence prepayment speeds. Smaller loans typically refinance slower but turnover faster. This held true over the last year—smaller VA loans prepaid faster than bigger VA loans, and smaller FHA loans prepaid faster than bigger FHA loans. Historically FHA and VA turnover speeds were comparable, and possibly FHA loans were faster. But those were not deep discount environments, suggesting that VA loans might have less lock-in than other loan types.

Exhibit 2. Low-balance VA loans prepaid the fastest last year.

Source: Fannie Mae, Freddie Mac, Ginnie Mae, Santander US Capital Markets

The 2020 vintage FHA loans were much slower than the other loan types in 2021. This backs up the theory that the 15 CPR to 20 CPR prints from 2% government loans were likely boosted by refinancing. The small balance FHA borrowers may be less efficient at taking advantage of refinance opportunities.

Faster speeds in low FICO

Borrowers with low credit scores in low-rate mortgages were more likely to prepay last year than other conventional borrowers (Exhibit 3). Some of these borrowers may be in starter homes and can afford a better home as their credit and income improve, while others might be more likely to default. The gap was wider at the start of 2022 before mortgage rates spiked higher but stayed positive throughout the year and thus far in 2023. The 2020 high LTV loans eventually prepaid faster than the standard conventional loans and almost as fast as the low FICO loans, likely the result of strong home price appreciation. The 2021 vintage high LTV loans have caught up to the standard conventional loans while lagging the low FICO loans, but these loans did not experience as much HPA as the 2020 vintage.

Exhibit 3. Low credit scores lift turnover for conventional loans.

Low FICO loans have credit scores <700. High LTV loans have LTV>80. The dark blue line are loans that have FICO≥700 and original LTV≤80.
Source: Fannie Mae, Freddie Mac, Santander US Capital Markets