The Department of Veterans Affairs is reviewing the more than 6,000 companies participating in its mortgage program in an effort to cull out unscrupulous lenders.

The sweeping inquiry underscores the department's fears that the hands- off nature of its streamlined refinancing program has permitted abuses. The program requires little paperwork and allows lenders to participate without background checks.

In some cases, lenders were charging as much as 7% to refinance loans to current market rates.

"We're reviewing all companies, because we don't know at this point who the lenders are" that may have charged excessive fees, said R. Keith Pedigo, director of the department's loan guaranty service.

"The only fair way to approach this is to look at all the lenders who have generated interest rate reduction loans," he said. The process should take a few months, he added.

Loans written by most of the larger lenders have already been inspected, according to a lender heavily involved in the loan program.

Although most lenders support the department's review, there is some worry that the emphasis on the fees, known as discount points, will unfairly target honest lenders.

"Our concern is that when they do this review, they should take into account that when some lenders charged higher points, they charged lower interest rates," said Brian Chappelle, staff vice president at the Mortgage Bankers Association of America.

Lenders involved in VA loans are already more than a little upset. The reason: guidelines issued two weeks ago that limit lenders to charging no more than two discount points.

Many in the industry are indignant, saying the department is punishing all lenders that refinance VA loans because of the sins of a few.

"You don't throw the whole barrel away because of a few bad apples," said Louis Jennings, executive vice president, mortgage lending, at the Vienna, Va., Navy Federal Credit Union. "You pick out those lenders and punish them."

No action has been taken yet against lenders that have written loans with high discount-point charges, because their actions are not illegal under current guidelines.

"If our existing (two-point-limit) policy stays in place, we've effectively nipped the problem in the bud," said Mr. Pedigo.

Although compliance with the two-point ceiling is only voluntary at the present time, Mr. Pedigo expects that interim regulations will become mandatory.

Before that can happen, the Veterans Affairs Department is required to open the policy to comments from the industry. "They may say, 'This is the greatest thing since sliced bread,' or they may feel this is excessive market intervention," said Mr. Pedigo.

Given most lenders' reactions, formal commentary is sure to lean toward the latter.

"I would like to know how the VA came to the conclusion that this is the best way to prevent abuses," said Barry Stricklin, vice president of mortgage services with the Pentagon Federal Credit Union in Alexandria, Va.

Some lenders said the point limit seriously reduces the number of options mortgage lenders can offer to homeowners who want to refinance.

"By limiting discount points to two to prevent gouging, it limits the ability of honest lenders to offer customers the ability to buy down interest rates," said Brian McDonnell, president-elect of Navy Federal Credit Union.

The two-point cap is not hurting most lenders during the current low interest rate environment, they say, but there is concern that an increase in interest rates coupled with the strict point limit would cut down on refinancing volume, keeping veterans in high-rate mortgages.

"It would be a real shame if this ended up precluding veterans from getting an option to lower their interest rate," said Mr. Chappelle of the Mortgage Bankers Association.

The streamlined refinancing program was originally instituted to encourage veterans to reduce their interest rates, thus keeping foreclosure rates down.

Lenders are also up in arms about a disclaimer that borrowers must sign if their refinanced loan includes more than two discount points. "That statement reads like the lender is guilty," said Mr. Chappelle.

Any further actions that the Veterans Affairs Department does take are sure to be closely watched by lenders.

"You can't regulate crooks," added Mr. McDonnell. The department's current actions are "just an overreaction," he said, but "you don't want the pendulum to swing too far."

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