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Author Topic: How do mortgages work?
JoshuaD
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I'm trying to get my head around this financial mess a bit. What happens to someone who has a mortgage on a house that gets foreclosed on, and the sale of the house is unable to cover the full cost of the mortgage? Do they owe the remaining balance or is the bank forced to eat that?
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TomDavidson
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The bank eats that. Basically, a foreclosure is when the bank takes possession of the house away from the debtor. (The debtor gets nothing, except now they no longer have to repay the remainder of the debt; to reflect this, their credit is now ruined for years.) The bank then attempts to sell the home, usually quite quickly; it is often willing to accept a loss on the sale to avoid having to float something on the market for a long time.

[ March 14, 2009, 02:44 PM: Message edited by: TomDavidson ]

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scifibum
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I thought lenders could still get deficiency judgments against the borrower in some cases, for the difference between the mortgage balance and the proceeds from the sale of the foreclosed property.
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munga
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quote:
Originally posted by TomDavidson:
The bank eats that.

Let me help that a bit.

The bank eats that, in that the bank doesn't get paid. But remember, the bank could pay itself, it just chooses not to. Instead, it re-sells the asset. If necessary they rent it out, or send in someone to evaluate if they put in 10k could they get out 50k upon the sale (here and there, there are such improvements).

I think the question you are asking is, when a person has brought to the bank a proposal to mortgage at 200k, and the party puts down (let's say) 20k, and then, that equals a 180k mortgage.

The bank combines the 20 and the 180 and pays the previous owner and the title is transferred.

So, the person loses the job because of the economy, is three months behind and is foreclosed upon, three months later. Worse, the housing market has tumbled and the Let's say values are plummetting, and the house is now worth 180k. In this case, the bank is doing fine because the bank is now the owner of a home that is worth 180k, and can re-sell it.

If the home is worth 150k, well, the bank is 30k in the red. The bank can re-sell it, at that price and (remember how mortgages work) they will make 4x the value of the home over the period of the mortgage (mmmmmmuuuuuuuch more than the 30k they felt so deprived of). Even if houses fell by half, that would mean that the mortgage would still cover it. And don't think that buying and selling (or in other words, releasing mortgages early by safisfying and replacing early) damages them, because they tack on so many fees these days the Truth in Lending rules now say they have to reveal ACTUAL "interest" as an APR disclosure (not that that is perfect either).

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munga
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quote:
Originally posted by scifibum:
I thought lenders could still get deficiency judgments against the borrower in some cases, for the difference between the mortgage balance and the proceeds from the sale of the foreclosed property.

Yes, they can and do. Because they are the scum of the earth.

That is because they tie mortgages twice- to the collateral- the home, and to your futureflow - making it a collateralized "signature loan" JUST so that they can come and get MORE if they might possibly ever suffer.

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dtd
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Well, that depends upon what state you live in. For instance in California all mortgages used to purchase a house are categorized as non-recourse loans. That is the bank has no recourse other than taking over the property.

A lot of people here also refinanced their homes to pull out money from their 'home equity' for all sorts of things, cars, vacations, medical expenses, college tuition, etc. What they don't tell you is that when you refinance in California, you turn your non-recourse mortgage/loan into a recourse mortgage/loan. Once this is done the mortgage company can sue you for the difference if you go into foreclosure. The only way to avoid it is to either get them to accept a short sale (without recourse), pay off the difference yourself, or declare bankruptcy.

Otherwise they have you by the short hairs... [Eek!]

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Colin JM0397
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It gets more shady when you look at the mechanics of fractional reserve banking where they only have to put up $1 for every $9 loaned.

The note itself is what the bank used to build the funds, meaning they put up only 1/10th of the value of the loan and the promise to repay it amounts for the other 90%, so they create the funds out of thin air and this is all perfectly legal.

The bank then holds that note as an asset that they can they also leverage out at 1-9. So, in effect, when a person forecloses the bank only "looses" money in the fact that the note falls off their books. However, they also now own a hard value asset they can unload for, example, only .20 on the dollar and still have pulled a profit.

You have to assume operation costs and overhead for the bank. Nevertheless fractional reserve banking is the biggest legal scam in the world... And most of your lenders probably have absolutely no idea how the mechanics work.

However, through all the smoke and mirrors and the condescending BS that us lay people can't grasp finance and lending, they make you think you actually borrowed money from them. It is crap – they system is actually very simple to understand. You actually borrowed most of the money from yourself. If, as in Munga's example, the bank didn't have to put up a single penny b/c you gave them the 10% down. They'll take your money and your house and profit any which way you look at it, however, not nearly as much if they hold your note for, say, 15 years.

Banks could offer us 0% interest loans and still make around a 80% profit. Granted, that would be over 20-30 years on a traditional mortgage, yet still quite a nice return.

And, of course, if you or I tried to do this we would go to jail for wire fraud, money laundering, racketeering, etc.

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LoneSnark
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No, you are skipping a step. A bank cannot lend out more money than it has. So, if the bank has $10, then it can only lend out $10 right now.

What you are talking about is the long-term effects. A bank has $10, lends out $9 which gets spent and deposited back into the bank, so the bank has $9 which it lends out $8.1, which gets spent and deposited back into the bank, so the bank has $8.1. This process continues until out of $10 it started with it has loans adding up to $90.

But at any given instance of time a bank cannot lend out more money than it has on account either from its original investors or depositors.

Now, this was not always the case. Back in the day before the Federal Reserve took command of demand transfers and all accounts became settled nightly, banks could play the game you describe, but it was very risky. When a bank makes a loan there is a high probability it will be deposited into a competitor bank, which always had the option of demanding payment immediately in whatever was convertible at the time, be it cash or gold. Which, if a bank was lending without cover by printing and lending paper notes (which today have been replaced by checks and debit cards), then it would be unable to service the demand, resulting in bankruptcy and one fewer competitor.

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munga
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Lone,

I do wonder if you've heard of leveraging?

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Colin JM0397
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LS, nope.
By banking rules in the US, a bank is allowed to leveradge at 10-1 for each dollar deposited.

The compounding effect you are going through happens at a 10x rate beyond what you are showing.

Wikipedia's site explains it fairly accurately. However, they are using 1-5 (20%) as their primary example of how it works.
Check out the charts showing various percents and take a gander at the 10% line; that's officially what banks are allowed to do with straight loans.

However, with the CDS's and all that junk, they found a way to leverage at a much higher rate - estimates are 38-1 in Europe, 28-1 in the US, and 16-1 in Canada... Which one of the three is having no financial crisis at this time, eh?

But that's beside the point. 10-1 right off the bat on the first loan is what is legally allowed in the US. So, on my original example, the bank only has to hold back 10% of the loan for collateral.
10% of $200,000 is $20,000.

What’s really maddening beyond that is a bank really doesn’t have to do that. What they do is take the note a customer signs, put that note on their books as an asset, and then use that asset to lend against for the loan. I don’t know, but it would be interesting to see what the “value” of that note is in the bank; the original note amount, or the full term payoff amount? This is how a mortgage broker can write a loan and then immediately sell it for pennies on the dollar. So long as they get more than 10% + their operating costs (which the lender usually already paid for by the origination fees and points), then it’s a good sale and they have absolutely no risk… and the banks that buy a lot of these items then have “toxic assets”.

Just thinking out loud now, but perhaps it would go a long way to fixing this mess to require whomever writes the note to hold it to term or its paid off. That would kill the CDS’s and a lot of the toxic assets, but would have the side effect of making it much more difficult to get a loan…

Side note, looking at the charts also look at the M1-M3 graphs showing worldwide money expansion. The US stopped publishing their M3 numbers about 18 months ago, IIRC. Now why would they do that?
Could it maybe have something to do with that 2+ trillion the Fed is refusing to identify where it went? What's the fractional reserve calculation on 2+ trillion being dumped into the economy at once? [Eek!]

[ March 16, 2009, 08:41 AM: Message edited by: Colin JM0397 ]

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Pyrtolin
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quote:
Originally posted by Colin JM0397:
However, with the CDS's and all that junk, they found a way to leverage at a much higher rate - estimates are 38-1 in Europe, 28-1 in the US, and 16-1 in Canada... Which one of the three is having no financial crisis at this time, eh?

The higher leverage had nothing to do with any of the instruments used; Investment Banks were explicitly allowed that much higher leverage level out of the gate. The GLB act just allowed them to apply that leverage to things like mortgages, which had previously been restricted to commercial banks with much less allowed leverage.
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LoneSnark
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It is important to distinguish between cash and promises to pay. A $20 bill is cash, a debit card is not. A debit card is the promise of your bank to pay if/when the time comes.

Now, the post I responded to asserted that banks created money out of thin air, which is untrue because the money created is not cash, for the reason I stated. Leveraging is not creating money, it is borrowing it from others to invest yourself. You cannot leverage without finding someone with money willing to lend it.

And as the wikipedia article explains, at any given instance there is only $100 in cash in circulation (although by step K all of it is in bank vaults). The money being created is not cash, it is "chequebook money" as they call it, or a promise to pay cash if/when demanded, which today takes the form of checkbooks and debit cards.

And this is not the only mechanism of promisory money creation. Afterall, money is anything that someone will accept as payment. A credit card with a credit limit of $5000 serves as $5000 worth of money, even if the credit card company itself does not have $5000 on hand to cover your charges. When the time comes to settle up with your merchants, it can borrow the money or pay them in kind (their own credit card bill).

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JoshuaD
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So no one answered the original question. Who's left holding the bag? Is it state-by-state? Is it dependent on the mortgage contract?
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Colin JM0397
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LS, right the original amount of cash doesn't expand. Nevertheless, the overall money supply (G3) does expand exponentially. From a consumer’s standpoint, Federal reserve dollars or checkbook dollars don’t matter.

If I take my 30-year mortgage to term, from 20k there is now a new 200K+ in circulation. Granted, it is the checkbook money. Nevertheless, it is in the system and can function like "real" money… Until it evaporates one day, that is.

------------

Josh, there are a multitude of programs that protect the bank there. When you get a mortgage and pay PMI, that is not - as they usually tell you, for your protection. It covers the bank's ass in case there are losses: http://en.wikipedia.org/wiki/Private_Mortgage_Insurance
In the case of a traditional mortgage with PMI, the insurance company that wrote the PMI policy eats the difference.
And you pay that premium!

On that note, if you have a conventional mortgage and your loan to value is under 80%, you can call the lender and demand they remove PMI. They will drag their feet, but they have to do it.
The interesting thing is, with values dropping, could a mortgage lender put PMI back onto an account and hit you with an increased monthly payment.

Sometimes you don't need PMI becuase you are in a government-backed program such as a VA loan or FHA first time buyer. In this case, the government provides the same guarentee that PMI does.

Notice in very, very few cases is the bank ever left "holding the bag".

However, based on the mechanics of fiat money and all that jazz, the loss of the note from the banks book is the loss of future income they would have gained from using that note as collateral to write more notes, and/or the principal + interest money cash cow.

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Jon Camp
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quote:
Originally posted by Colin JM0397:
Sometimes you don't need PMI becuase you are in a government-backed program such as a VA loan or FHA first time buyer. In this case, the government provides the same guarentee that PMI does.

Erm... FHA loans have PMI built in to them for the entire term of the loan, not merely the 1st 20% equity like PMI.

******************************************

I used to file foreclosure claims. I was trained on "conventionals" and thus was filing for the PMI, but after about a month of that I got tossed on to FHA, VA, and FmHA, so I never really got "good" with the conventionals, but I know the FHA program like the back of my hand. VA is actually the "best" of the govt programs, IMO, and I think a fairly decent "thank you" to our vets. I don't think ANYONE truly understands the FmHA program. I only filed 3 or 4 of those in the year I did this work, and I just followed the instructions as best I could. The guy we filed them with said I filed the best claims he'd ever seen though, so I guess I can follow the manual. . . it still never made sense to me, though.

Anyway:

For the "conventional" with PMI --

You buy a home. You personally put down 5%, and thus take a mortgage of 95%. You even pay all the closing costs out of pocket instead of rolling them into the loan. The lender requires you to have PMI since you don't have 20% equity.

A year later you have something happen and stop making your mortgage payments. In that 1st year you only actually pay about 1.5% toward the principal on your loan -- the rest of your payment is ALL interest on the loan. So, assuming home values were stable, you still owe about 93.2% on the home.

On top of this, the principal keeps accruing interest, since you aren't making the payments anymore to pay the interest off each month.

After 3 months of missed payments, the lender moves to foreclose and hires a lawyer to sue for foreclosure in court.

Depending on the state, court fees vary, and the amount of time it takes for the court to say "Foreclose away" vary as well. Most take about 5-8 months, but some (*coughNewYorkcough*) can take as long as 19 months.

Interest accrues the entire time. The lender will also pay any escrows required in order to "protect their collateral." -- No sense in letting the state seize it for taxes, after all. And of course the lawyer's bills and the court costs are added on top of this also. Add it all together and you get the "total debt."

The house is put on the auction block. The lender's representative bids 80% of the total debt. If anyone else bids even so much as $0.01 more, the lender will NOT (indeed is bound by law not to do so) bid up the price, though most auctions do require a minimum of $1 more ;-)

Anyway... assuming that the lender wins the auction, they "pay themselves" the 80% of total debt and then file the PMI claim for the other 20% and try to sell the "asset" on the open market. They are able to sell it for full market value, but due to time on the market and the fact that they still have to keep paying taxes, upkeep, maintenance, insurance, and the broker's commission -- it's rare that a bank actually profits from a foreclosure. The PMI helps prevent them taking a bigger bath, is all.

Banks hate this. They're in the money business, not the real estate business. One thing is certain in the mortgage business: They do NOT want to foreclose your home. They will try just about anything via payment arrangements or even a short sale in order to not have to foreclose.

If the price of the home has fallen, then the bank usually *can* petition for a deficiency judgment, but most don't bother. You couldn't pay the mortgage, so it's not like you can pay the deficiency either, and if they pursue it then they have to add in more court costs and also collections fees as well. It's generally not worth it to them.

************************

FHA's program is a bit different. They have their own "pmi" which actually goes for the entire life of the loan. None of this "Hey I have 20% equity, so cancel the PMI!" business.

How it works for the lender is this:

Borrower stops making payments. Foreclosure gets started, house goes to auction. All that interest, escrow, and lawyer/court costs mentioned above still apply (though HUD has maximums it will pay a lawyer), but are totaled out separately.

At the auction, the lender's agent bids for principal plus the interest up to that point.

Assuming the lenders "wins" the auction, they pay themselves and then have a period of time in which to transfer title over to HUD. Once the title is transferred, HUD pays the lender the auctioned amount, and once they determine that they have clear title they then approve the lender to file a 2nd claim for all the escrows, laywer fees, and court costs (plus interest. . . . )

Banks actually really like this: They lose nothing under this program, plus they don't have to sell the house -- it's HUD's problem, not theirs.

*********************

VA is a little trickier. It's more similar to the conventional, in that only 80% of "total debt" is bid at the auction, but it's actually the VA bidding, not the lender. The VA then pays the lender off and the lender files a claim for the remaining 20% plus costs.

How is this "better" for the vet in the house you ask? Well... the VA doesn't require the house be vacated before auction like the other 2 do, and the VA will usually let the vet and his/her family stay there and work out their own terms with the occupant later on.

But the bank doesn't care -- the VA paid them, and they don't have to worry about the house either, since the VA owns it.

So the lenders like the govt. programs either way. They can still end up taking a bath with them, too, but if they do it's becuz they screwed up the claim process, and even there they still get the principal + costs paid off no matter what -- they just get the interest cut to whatever date they missed a deadline. It's still a loss, but it's just a loss of profit, not an actual debt.

*****************

Something like 93% of all mortgages are always paid on time. Of the remaining 7%, only about half actually go into foreclosure. And 97% of all foreclosures take place when the loan is less than 3 years old, which essentially would lead one to believe that the vast majority of foreclosures are due to people buying more house than they can afford.

These numbers were vaild when I was doing all this back in the late 90's, anyway. With the current state of the economy, I don't know if they still hold true.

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