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Lenders' Loan Payback?

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Posted On: 04/30/2008

Q: Why are lenders crying the blues about defaults on subprime mortgages, especially those that have variable interest rates, when most of these borrowers have to pay for mortgage insurance? Don't lenders get paid back the principle by the insurance companies when the loans default? It seems to me that, although it is both the bank's and borrower's fault for letting these loans even happen, the insurance companies are taking the loss.

A: This is not as clear cut as it may seem. When a home is purchased with less than 20 percent down lenders insist on some form of mortgage insurance - either private mortgage insurance or protection under the VA and FHA programs.

With the VA and FHA the lender gets 100-percent coverage. With PMI, the coverage is equal to 20 to 30 percent of the loan value, depending on the amount down and other factors. Between the foreclosure value of the property and insurance, lenders are usually able to recover their principal.

The catch is that in a foreclosure situation a lender may have significant expenses beyond the dollar value of the loan. In congressional testimony it has been estimated that a typical foreclosure produces a $40,000 loss. Why? If a property is not sold at a foreclosure auction, it's taken back by the lender as "real-estate owned," an REO. The lender thus becomes the owner and is responsible for such costs as taxes, insurance, maintenance, security and re-selling the property.

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The result is that while insurance coverage surely helps, it often does not make lenders whole in the face of foreclosure. There is still risk - and cost - in the marketplace. In a sense, it's actually good that foreclosure means the potential for lender losses because this reality should encourage loan owners to modify financial terms where possible rather than foreclose.

Q: I'm in a situation that means I could lose my house. My house was appraised at $310,000 when I bought two years ago, though in reality it should have gone for not more than $230,000 - and that's stretching it. Now I'm in a situation where I cannot keep my payments up and will probably get foreclosed. Is there a way for me to come out of this OK?

A: No. You will not come out of this OK. If your numbers are correct, then at the time of application the loan amount was substantially larger than the market value of the property, thus it logically made no sense to buy the home. A bigger loan means steeper monthly payments and little chance to sell the property at a profit. You should have walked away.

Many appraisers report that lenders lean on them for larger valuations, valuations unjustified by the marketplace. There's some room for debate and discussion with appraisals because they're opinions of value, but changes and adjustments - if any - must still reflect marketplace realities.

Given that the size of your loan is vastly larger than the value of the property, the property cannot be refinanced without additional cash. Alternatively you will be foreclosed if payments cannot be maintained. In either case, unfortunately, you lose.

You have no choice but to speak with an attorney who specializes in foreclosures and bankruptcy.

Q: We, my wife and I just finished our Chapter 13 agreement last November and plan to sell our current house to buy a slightly bigger house. We are looking at having a nice family room and a garage that currently we don't have. We understand the current difficulties in real estate and that applying for a mortgage just after fulfilling our Chapter 13 is almost impossible. How should we prepare for this financial move? We both currently have credit scores between 650 to 695 and we are making sure we are doing all of our payments on time.

A: You cannot sell your home unless you can find a replacement property - and you can't get a replacement property without financing. The result is that you must have necessary mortgage financing in place before you go house hunting.

You need to speak with a variety of lenders to see what financing is available to you. You must obtain pre-approval letters from lenders that show how much you can borrow. Why? Because sellers will want to know that buyers have the financial capacity to complete a transaction.

In the best circumstances, FHA financing is potentially available in your situation after a year of good payments and with the satisfaction of other conditions. Have a local real estate broker introduce you to an established lender who can realistically review your situation.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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