In 2006, the infamous Implode-O-Meter was established to predict and announce all of the mortgage companies that were going belly up.
It was both fascinating and extremely helpful because it warned people to avoid lenders or investors (that buy loans) that were on the verge of bankruptcy.
It was fascinating for a few reasons: (1) Nobody expected to see so many huge players like Washington Mutual, HSBC Mortgage, and New Century Mortgage end up on the list; and (2) The website became a forum for employees to discuss all the fraud and corruption that went on within the lenders (which caused the temporary shutdown of the website because of the lawsuits the forum fostered).
To date, 388 mortgage firms have gone belly up, per the website.
Recent News Of Mortgage Firms Collapsing
Two recent “implosions” have recently been making the rounds and many are wondering if this is 2006 all over again; are we on the precipice of another major onslaught of implosions?
We are not on the verge of disaster because the two big recent implosions involved non-QM lenders – Sprout Mortgage and First Guaranty Mortgage.
Non-QM lenders are essentially the new version of the “subprime” lenders that dominated the housing market prior to 2008.
BUT – today’s non-QM lenders lend much more responsibly than any of the pre-2008 subprime lenders did – requiring much larger down payments and/or legitimate forms of documentation.
And – today’s non-QM lenders only represent a tiny fraction of the overall mortgage market (about 2% in 2020 and about 4% in early 2022).
Why Do Mortgage Companies Implode? (Not What You Think)
In 2008 a lot of mortgage firms went belly up simply because they had way too much overhead and needed to file for bankruptcy protection to get out of their obligations.
There were numerous stories of slimy companies not paying their employees their final paychecks while the former owners resided in mansions filled with Porsches, and there were others where the company owners walked away from tens of thousands of square feet of lease obligations because the landlords allowed them to sign “non-recourse” (with no personal liability). This is why creditors and landlords are leery of mortgage companies to this day.
Unsalable Loans: What Keeps Every Mortgage Lender Awake At Night
The other major cause of bankruptcy is/was unsalable loans. About 70% of all mortgages are funded by non-bank lenders or mortgage banks. Mortgage banks are different from commercial banks (like Wells Fargo or Chase) in that they only underwrite and fund mortgage loans; they do not hold deposits or do any of the activities that commercial banks do. Mortgage banks make almost all of their money by selling those loans off of their warehouse lines for a “premium” soon after the loans fund, e.g. if they fund a $100,000 loan, they will try to sell it for $105,000 on the secondary market within a week or two of funding.
If mortgage banks can’t sell those loans at a profit, they go out of business.
There are numerous reasons why a mortgage bank might not be able to sell a loan, including:
- They offered too low of a rate – so no investor would buy the loan (this is largely what happened to the Non-QM lenders above).
- They held the loan too long in a rising rate environment – making the loan worth much less (this is similar to above, and it too is what happened to the non-QM lenders above).
- Less liquidity in the market. This is something we are seeing now too, as there are fewer investors in the market looking to buy loans (especially non-QM loans).
The liquidity issue is what nearly pushed hundreds of responsible mortgage lenders out of business in 2008, as many investors, that had committed to buy loans from mortgage banks, simply refused to follow through with their commitments. This happened in 2020 when COVID hit, and it will likely happen again at some point.
Note too that mortgage banks are not allowed to just keep mortgage loans on their warehouse lines and just “service them,” as both regulators and warehouse line providers prohibit this.
When To Worry?
Currently, I would only worry if I had a loan in progress with a non-QM lender that was known to be “at risk.”
If a lender goes belly up while a loan is in underwriting, those loans will have to be pulled and taken to another lender to start the process over (causing significant delays to closing in most cases).
I would not worry about any standard “A Paper” (conforming, FHA or jumbo) loan with a broker, mortgage bank, or a commercial bank at this point.
What Happens If A Mortgage Lender Goes Belly Up Right After A Loan Funds?
Buyers and agents are in the clear once the loan funds and records. It is up to the mortgage lender and its creditors to find a buyer for that loan. The buyer/borrower is not at risk.
Can Borrowers Stop Paying Their Mortgage If Their Lender Goes Bankrupt?
The elimination of the mortgage lender does not mean the borrower’s promissory note and mortgage/deed of trust will disappear. Those notes are often held by other investors in any case (as discussed above); the servicers (who usually do not hold the notes but only collect payments) will still zealously pursue payments; and, even if the note is held by a bankrupt entity, the bankruptcy court will ensure that the note is sold or transferred to an entity that will demand payment.
Founder/Broker | JVM Lending
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