It’s all over the news, people losing their homes to
foreclosure and banks writing down billions of dollars in bad loans,
but I have recently learned something startling from friends and
colleagues we know in the lending business.
It starts by understanding that when a lender makes a
loan to a person or couple buying a home, the lender does not plan to
keep that loan on their books. They resell the loan in the “secondary”
market to investors looking for a return on their cash. These loans
are bundled into packages (now known as Mortgage Backed Securities)
and sold to investors. The lender makes a profit for placing the loans
and bundling the package for resale, when it is sold they get their
cash back and make more loans with it. The cycle continues and that is
what keeps money in “circulation”.
But as loans that were sold into this secondary
market begin to go bad when borrowers stop paying their mortgage, these
investors are left with a bag of what we call “bad paper” -- loans that
need to begin the foreclosure process. This is where it gets
interesting.
The banks and lenders who sold these investors the
bundled packages originally, are going back to these investors saying
“uh, it looks like you have some non-performing assets in there (a.k.a.
borrowers not paying their mortgage), maybe we can help.”
At this point, the bank makes an offer to buy the bad
loans back from the investor at a fraction of the price they were sold
originally. The bank then begins the foreclosure process and
eventually takes over the property, resells it to another buyer, and
recovers their cash. Since they bought the non-performing loan at a
huge discount, they are able to actually make a profit by foreclosing
and reselling the property at a higher price then they paid the
investor. Incredible!
Here is how it works:
1) Loan origination:
a. Borrower buys a home for $600,000 and signs up for a $480,000 mortgage loan at 7% interest
b. Lender bundles the loan commitment with other similar loans at 7%
for resale in secondary market to eager investors looking for safe
returns (like insurance companies)
2) Loan goes bad:
a. Borrower made a few payments, then missed a few payments, now the
$480,000 loan is not performing at 7% anymore and becomes marked as
“bad”
b. The investor begins to realize they are sitting on hundreds or thousands of such non-performing loans
3) Repurchasing:
a. The lender who originated the loan steps back in and approaches the investor on the bad loans they are holding
b. “I’m sorry to hear that $480,000 loan is not performing, but I’ll give you $288,000 for that bad loan”
c. Investor agrees to sale (something is better than nothing, it’s a
bad housing market out there and I’m not in the foreclosure business…)
d. The lender now owns the right to foreclose on the homeowner
4) Foreclosure and resale:
a. Through a bunch of legal paperwork, the foreclosure process closes and now the bank owns a property they need to sell quickly
b. The home is cleaned up and relisted on the open market at $450,000, a huge discount from the $600,000 original sale price
c. New buyer jumps on the idea of buying a foreclosure at a discount
d. In the end and just looking at raw numbers, the bank made $162,000
on the foreclosure ($450,000 sale price minus $288,000 purchase price)
I’m being told that this is happening all over the place by banks we thought were losing money in the foreclosure process…
-mark
Recent Comments