If you have missed a few mortgage payments and are now receiving phone calls and threatening letters from your friendly collection agent representing the lending institution, you may be shocked by the information that I am about to share with you in this article.
There is a huge misconception among the general public, and especially with homeowners in financial distress, when it comes to the topic of bank foreclosures. The great majority of homeowners have a strong misconception that the bank is out to get them, and that the bank wants to steal their home. They often fail to acknowledge that they have missed mortgage payments and have made no effort to contact their lending institution to explain their financial situation and seek financial assistance.
It may come as a shock to you to learn how banks and lending institutions operate in general. At one point in time I called this “the secret that banks don’t want you to know about”, but it’s hardly a secret at all. Understanding how lending institutions make money is a valuable piece of information that you can use to your advantage.
First of all, no one likes to lose money and banks are no exception. To reduce their risk, lending institutions protect themselves by securing mortgages with the properties that they are financing. This could be a house, a car, or anything of value. This gives the lender some reassurance that the property owner will pay back the borrowed money, plus interest, on time as specified in the original mortgage agreement. As long as the borrower keeps making the mortgage payments, everybody lives happily ever after. The bank is happy to report quarterly profits to its investors and the borrower has a nice, comfortable place to call home.
However, if the homeowner begins to fall behind with the mortgage payments, their dream of owning a home could become their worst nightmare. Not only for themselves but also for their lending institution. You may wonder, how can a foreclosure also be a nightmare for the bank?
Herein lies the great misconception regarding bank foreclosures. The bank does not want to foreclose on you! I know it sounds absurd, especially after getting off the phone with the bank collection agent or reading their last threatening letter, but bear with me. By the time you finish reading this article you will be persuaded that it is an accurate statement. Allow me to go even a step further. The very last thing the bank wants to do is foreclose on your property! The main reason the bank does not want to foreclose on your property is that the entire procedure will become an added expense to them. It costs the bank thousands of dollars in legal fees alone to foreclose on a property, not to mention the Realtor fee and property management fees. It is a very expensive process, and the number of foreclosure properties is increasing throughout the province. Now you may be asking yourself: If that's true, why is the bank collection agent threatening me with foreclosure? What do they really want?
The answer is simple; the bank collection agent wants to scare you into making up the late mortgage payments. The threat of foreclosure is a scare tactic that the collection agent uses to persuade you to make up the mortgage payments. To protect their investment they must ensure you will continue to make your payments on a regular basis until the end of the term as specified in the mortgage agreement.
Furthermore, once the bank initiates the foreclosure process, the laws regulating the banking industry require them to report that property as a non-performing asset (NPA). Doing this will hinder the bank’s capacity to borrow more money and will affect its overall credit rating. The bank must try to avoid having to report a non-performing asset on its books at all cost. In many cases, banks intentionally delay initiating a foreclosure proceeding for up to six months, and sometimes even up to a full year, to avoid reporting the property as a non-performing asset. In other instances they will start the foreclosure process as soon as you miss a mortgage payment. The main objective is to avoid having to report an asset as a NPA.
The ‘non-performing asset’ problem affects the banks in more ways than you and I may care to know. These three simple letters strike terror in the banking sector and business circles. The dreaded NPA rule simply states that: “When interest on a loan or any other monies is due to a bank and it remains unpaid for more than 90 days, the entire bank loan automatically becomes a non-performing asset”. They will go to great lengths to avoid having to report a property as a non-performing asset.
Why would three simple letters, “NPA,” cause such terror to a financial institution?
There are a number of problems that will arise from having too many NPAs on the bank’s books. The biggest problem is that the bank must have a certain amount of dollars in cash reserves. If their levels of non-performing assets become too high, they will have to put more cash into their reserve account to compensate for these non-performing assets. This means they now have less money to lend. In addition, they now have to deal with a house that they don’t want because it will become a money pit. Furthermore, from this point forward they will not be able to make a profit on this asset because of the way mortgages are structured.
In their quest to maximize profits, banks structure mortgages so that the borrower pays the majority of the interest upfront or at the beginning of the loan term. This is called a ‘front loaded mortgage,’ and most mortgages are structured in the same way. This means that as a borrower, the early years of your mortgage do not build much equity in the house as the majority of your mortgage payment goes toward the interest on the loan.
Often times banks find that their asset (your house) is worth less than what they lent out. In the real estate world, these types of properties are called ‘underwater properties’ and once the bank takes ownership of one of these properties, they not only have an administrative and legal nightmare, but they are about to take a financial bath!
Even though I am not a bank advocate, I am certain that if you were in the bank’s situation, you would be forced to do the exact same thing. The bank does not have any evil intentions towards you, it simply has no other recourse. The only legal recourse available to them is foreclosure, which helps them minimize their losses. Foreclosure is however, the bank’s least favourable option. As the borrower you may be able to avoid a foreclosure situation simply by approaching the bank and cooperating with them. This can minimize everyone’s losses.
Can you now see the predicament that lending institutions find themselves in? On the one hand, they are losing money by not receiving your mortgage payment and on the other hand, they can’t really afford to foreclose on you because of the negative consequences this will bring them.
While this is an admittedly simplified explanation of how financial institutions operate, the bottom line is that banks are in the money buying and selling business. To put it in clear and simple terms, the bank’s profit is generated by the spread created between the interest rate that they pay you on your deposits and the interest rates they charge on the money that they lend out. The bank pockets the difference. For the bank to make any money, it must lend out the funds in its possession, or find some sort of investment vehicle that will guarantee a rate of return greater than its cost of borrowing.
Consider the main motivating factor for a bank to be in business. The bank is not a charitable organization, they are in business to make money. Because a foreclosure will likely cause them to lose money, it’s a path they would like to avoid if at all possible.
Warren Buffet has only two financial rules. Rule number one is “Never lose money” and the second rule is “never forget rule number one”. As the old saying goes, the best way to make money is to stop losing money and the foreclosure path is not the best way for you and the lending institution to stop losing money.
Now that you’re clear about lending institutions’ motives and how they operate, what will you do with this knowledge? Don’t you think it would be wise to call your lending officer, find common ground, and work out an agreement that will stop the foreclosure process and satisfy both your needs and bank needs?
Remember, the bank does not want your house. The sooner you work out an agreement with the lending institution the less expensive it will be for you and the bank. There are court filing fees, legal fees, and penalties. You can avoid all that by simply talking to your mortgage broker or lending office.
I hope you enjoy reading my article regarding the misconception on bank foreclosures. Please remember to visit my website www.jbenitez.ca where you will find other related articles and remember to like my Facebook page.
Joaquin Benitez is a licensed real estate agent and author of the book, The Foreclosure Phenomenon: How to Defend Your Home from an Impending Foreclosure, available at Amazon.com and chapters.indigo.ca