Institutional lenders are among Americas most regulated industries. They must conduct their operations under the continuous scrutiny of a number of federal and State agencies, as well as consumer advocacy groups and in accordance with a host of regulations and laws. In short, while they may seem to be in command when a person is trying to get a loan, they are most definitely under the gun when that same person stops paying.
The institution that a person is making payments to is rarely the same institution that loaned the money to him or her. The loan is sold and the institution receiving payments is merely servicing it for a fee.
Lenders raise money by packaging loans of a certain quality according to certain underwriting standards and either selling these packages directly into the secondary mortgage market provided by GNMA, FNMA, and Freddy Mac; or various Hedge Funds, or they issue bonds and sell them on the open market.
When there are a lot of defaulted mortgage loans, as there are today, the yields promised by the lenders to their investors don’t materialize and the investors want their money back. The lenders don’t have it to pay back. It has already been loaned out to other borrowers. This creates both legal and regulatory problems for them. For this reason, they sometimes continue to make payments out of borrowed reserves without admitting that a loan is in default. This is what caused the great RTC scandal of the 1980s, and may cause much larger scandal this time around. But, that’s not the worst of it:
As a rule, mortgage lenders don’t lend their own money, they borrow it from the Federal Reserve Bank and must pay interest on what they borrow. This works fine so long as they are receiving payments. The Fed has its own underwriting standards that it varies to try to stabilize the mortgage market. They expect banks who borrow from them to report accurately on the quality of their loan portfolios; particularly with regard to defaults and late payments.
When a house is foreclosed, the amount of the unpaid loan balance is subtracted from their reserves. This reduces the amount of money they can borrow from the FED, and sharply cuts into their profit margins. What’ s more, when they load up with REO properties, the Fed often requires them to hold forced liquidation sales. This forces them to tell the truth about their financial condition, and the quality of other loans they may have that are delinquent. Lenders live in fear that they will be charged with deceptive practices and sold off to other companies. This makes them vulnerable to cash offers.
Veribanc, Inc., (401)766-5300, is a banking information company that specializes in reports on the financial strength of banks. For a modest sum, it is possible to obtain the latest mandatory reports filed by any bank in America. When you target a lender’s REO department (Real Estate Owned) to see about buying foreclosed inventory that it has taken back, it can give you a stronger negotiating position to see just how many houses they have to sell.
You’d be surprised at the deal some lenders will make today. For example, Vanderbilt Mortgage company offered to sell a relatively new 1144 square foot model that it had on its repo lot. The defaulted loan balance had been $49,000, but they agreed to sell it for $8000 cash. In another instance, I bought a $19,326 second mortgage loan behind a defaulted $78,469 first mortgage that was held by GE Capital. They accepted $1000 for it. That amounted to five cents on the dollar for this loan rather than investing even more money to protect it at foreclosure.
One retired lady I know makes a living buying deeply discounted defaulted second mortgages behind default first mortgages on houses that she is willing and able to bid up at foreclosure sale. She’s pretty adroit at picking houses that bidders will pay top dollar for, but, if she is the only bidder, she gets the house for a pittance over the first mortgage balance.
One house she bought had a defaulted second mortgage with an unpaid balance of $28,453 for $7200. It was behind a defaulted first mortgage of $119,622. The house was worth about $200,000 on the retail market. When it went to auction, she bid the price up to $150,000 and stopped bidding. Competing bidders bid the price up to $167,000. The loan that she had owned less than 30 days was paid off in full and she walked away with a $21,253 profit. Had no other bidders topped her $150,000 bid, she would have bought a $200,000 house for a net $126,822 after reducing her cost by the amount of the second mortgage loan, which would have been repaid to her. Either way she would have come out winners.
Give this some serious thought. Without any need for management, title searches, maintenance, or liability, simply buying junior liens behind foreclosing senior liens can create huge profits. All you’ve got to do is to round up financial backers who will lend you the money you need to bid with at foreclosure sales in the event you wind up with the house. If you are willing to divvy up profits 50/50 you should have little trouble finding investors.