Let’s say I bought a house for $100,000 a year ago that was recently appraised at $120,000. I run down to my bank and take an equity loan out for $15,000.
Tomorrow, it will be revealed that an old toxic waste dump was found across the street. My house valuation just went to $30,000 as a result. (not really…just a hypothetical)
Does the bank do anything about this (assume they know somehow) or is it just tough luck for them and they have to hope I continue to pay off my loan?
Unless they have a clause specifically calling for foreclosure in the event of a loss of property value, I’d guess they’ll have to bite their nails. The appraisal and the fair market value are a tool for determining risk; they’re not a part of the note or the deed.
This happened here in the UK in the late 1980’s. The official term is "negative equity " when you house becomes worth less than the loan ( or mortgage ) you have taken out to buy the property. In many cases the lenders re-possesed the house when the payments could not be kept up and the people found themselves out on the street. When the property was sold they got some share of the sale. There are real fears that this might happen again . Property prices are rising by over 20% a year and people are taking out such huge loans that they are leaving themselves open to losing their home if their circumsatnces change and they cannot meet the repayments and the price of property starts to fall.
That’s rather irrelevant. No matter how much equity you have, no matter how much the house is worth, you can lose it if you don’t keep up payments*. The question is “does market value matter if you DO keep up payments?”
*Yes, I know that having equity may make it possible to restructure your loan so that you won’t lose the house; nonetheless, foreclosure IS possible.
The bank is likely to do something, but it doesn’t involve the customer. If FDIC related the bank may be required to recatorigize the loan as “doubtful”, “underwater” or something and may have to make an adjustment to general or specific loss reserves.
If your loan is inadequately secured, the bank may ask you to put up further security, or alternatively may put up the interest rate (assuming the loan agreement allows this, and my wild guess would be that it does). The loan agreement may allow the bank to call in the loan and foreclose on the property, but I would guess that they are very unlikely to do this as long as the payments are maintained.
Also note that if the bank forecloses on your property but sells it at public auction for less than the outstanding debt you still owe them the difference. But of course this is now an unsecured debt and they must join the other unsecured creditors if you declare bankruptcy. Often, the bank won’t bother to collect this difference. But then if the IRS gets wind of this they will consider the forgiven debt as income and demand income taxes on it. And of course if we’re talking about a house you were living in the IRS won’t let you deduct the loss in value as a capital loss because you didn’t buy the house for the purpose of making money. You can’t win for losing!
How is the bank going to know? The certainly don’t have people on staff keeping track of the value of homes they have loans for. I would be very surprised if you kept up on the payments that they would or could do anything.
I agree with RufusLeaking post.
Forgiveness of debt relative to home mortgage foreclosure will seldom happen however.
Significant under bids(below the loan payoff) exposes the lender to potential lawsuits by the original owner. If the lender later resells the property at or above the bid, the owner may claim they cheated on the foreclosure bid. If the bank sells at foreclosure between the bid and the loan payoff, the owner may claim the lender and successful bidder were in cahoots. Such suits may not be successful, but lenders don’t wish to defend them.
Lenders will not overbid for obvious reasons, so most bids are at or very close to the actual payoff, including legal costs.
BTW, it’s often the case the only bidder at a mortgage forclosure is the lender. If there was any equity, the owner is unlikely to have reached default.
Negative equity and delinquency/loan default are generally highly correlated. The nonpayers and the no-equity loans are pretty much the same list.
>> Also note that if the bank forecloses on your property but sells it at public auction for less than the outstanding debt you still owe them the difference.
It depends on the jurisdiction. Some states have laws saying the lender can not go after the defaulter for the difference. I believe CA is one of them.
It’s my hypothetical so I can play it any way I want ;)!
I agree the banks can’t track all of this but in my case this newly found toxic waste dump undoubtedly made the news. Is it unreasonable to suppose bankers ran in the office the next day and wanted to find out what their exposure was in the area?
Two scenarios on a home with negative equity:
You keep paying and the bank cashes your check until it is paid off.
You keep paying but the bank forecloses, goes thru auctions, tries to collect the diff., etc.
Guess which one the bank prefers?
It only becomes an issue if you don’t make payments or you can’t pay back the loan when you sell the house before it’s paid off. There’s also secondary issues such as if you try to get a loan to buy a vacation home and the mort. broker finds you have negative net worth.
Also, if you try to sell it and can’t get the full mortgage amount, the bank can refuse to let you. Say you have an offer of $100K and you owe the bank $175K. The bank can say “No Way.” Then you’re stuck again.
They could agree to what we call a “short sale,” where the bank agrees to let you sell the property for less, they get what they can and take it all, and you get nothing.