Mortgage lender bankrupt & no one buys loan?

Question

With all the news about the credit cirsis, a question comes to my mind. Let's say there's this hypothetical situation: I have a loan with company ABC. It goes bankrupt. I understand that my loan would usually be sold to XYZ and that I'll just start making payments to XYZ. Here's the interesting twist. Let's say that I'm really bad at making on-time payments, and my house value has dropped since I bought it. Why would XYZ want to buy my loan from ABC? With many of the mortgage companies deciding they don't want low value loans, they shouldn't want to buy my loan. I can't imagine a court ordering another bank to take over the loan - so what happens then?

If the loan gets sold as a bundle to another bank, then why would XYZ want to buy the bundle that has a lot of risky loans?

Thanks in advance!

Answer 1

Most loans are securitized (sold) so your loan is in a "pool" somewhere already. Very few companies hold a portfolio of loans. But lets suppose your loan is being held by the mortgage company. The simple answer is that there is a price for every asset (in this case loan). Just like going to any other "Going out of business" sale.
If it were a bad loan it would be sold at a discount. Say you owe $100,000 on your loan and you didn't make your payments on time and your house value went down. If company ABC were forced to sell the loan then company XYZ could buy it for something less, like $90,000. Company ABC takes a $10,000 loss. Company XYZ now has a $10,000 cushion to absorb a potential future loss on your loan.
The reverse is true too; good loans are sold at a premium. Company XYZ is willing to pay more than $100,000 because they are guessing the loss potential is small.

Answer 2

The loans would be sold in a bundle at a discounted price. Risky loans tend to have higher interest rates. They're betting most of the loans will be paid and only a few will default.

Answer 3

Because the courts will require that the assets (your loan is an asset to the mortgage company) be sold.

You might owe 200 grand on your mortgage, and your mortgage might be sold at the wholesale rate of 100 grand... but you still owe 200 grand to the new bank.

If you fail to pay, the new bank will foreclose, and sell your house for 120 grand.... they still made 20 grand AND you still owe them the other 80.

It's a pretty sweet deal for the bank buying the loan. The simple fact is your loan will be bundled and sold... that mortgage company is obligated to shareholders and investors that gave them the money to give to you... the bank is your creditor, and the bank has creditors as well... they are not just going to walk away from it.

Answer 4

That is an extremely good question. My home loan is with a lender that just went belly up. No matter who assumes your loan, they are making money off it over the interest you pay, right? So even it is a small amount, it would be in any banks interest to make something over nothing. I also pay PMI insurance until 20% of my home is paid for. That guarantees the bank will make their money if I default on the loan (PMI is tax deductable this year, btw). The housing value question has me stumped however. Is that just because of the general state of the housing market? Hopefully that will turn around (maybe after the next election? wink, wink).

Answer 5

I work for one of the largest mortgage banks in the country. You do not understand secondary marketing or capital markets so it's hard to explain. I purchase loans from bankers on a "whole" basis but those packaged into mortgage backed securities (MBS's) which are known as fixed income bonds.

Essentially, "whole loans" or even "pooled" loans are RARELY sold on wall street. They are "pooled" but "broken up" into tiny little pieces and sold to various people. 50 people might own a "piece" of one loan. These pieces are then pooled with other loan pieces in varying degree of risk. So even if a loan goes bad the losses get spread out therefore reducing each investors exposure.

The company you send your payments into each month generally does not actually "hold" the loan. They are merely the "servicer" who collects payments and dispurses to investors. My bank keeps less than 10% of our loans on our portfolio. If we were to go bankrupt then the investor would find a new "servicer" and transfer rights to that company. If you've had your mortgage for a whlie you might have already changed servicers more than once.

You hit the nail and head with your last statement. Why would anyone want to buy risky loans? The answer is NO ONE. That's why we are in a liquidity crisis on wall street. Wall street turned off the money supply to lenders who need fresh capital to generate new loans. Now we can only sell loans to Fannie Mae / Freddie Mac (quasi government corporations) who have much tighter lending standards.

Answer 6

In reference to Ga.peach's comment on PMI being tax deductable this year.....that is only if you took your loan out as of 1/1/2007. A new federal law provides for an itemized deduction on federal tax returns for the cost of private mortgage insurance premiums paid by eligible borrowers for purchases or refinance transactions. The new law allows borrowers with adjusted gross incomes up to $100,000 to deduct 100% of their 2007 PMI premiums on their federal tax returns.

In addition, borrowers with adjusted gross incomes up to $109,000 can take advantage of a partial PMI tax deduction (the legislation includes a phase out by 10% for each $1,000 a taxpayer’s adjusted gross income exceeds $100,000 with a cutoff of any deduction at $109,000). The legislation is effective for mortgage insurance certificates issued between January 1 and December 31, 2007. The legislation specifies that the tax deduction applies to PMI contracts issued between January 1 and December 31, 2007. Congress can choose to extend them on an annual basis.