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Lenders get nervous when borrowers go bankrupt. But considering what's going on in the mortgage industry lately, consumers should be the ones worrying.
Several mortgage and home equity lenders have thrown in the towel and filed for bankruptcy protection during the past two years. Subprime lenders, which make loans to people with spotty credit, have fallen particularly hard, losing hundreds of millions of dollars since Russia's 1998 debt default made obtaining money for new mortgages more difficult.
In theory, a lender bankruptcy isn't supposed to matter to consumers. Another company comes in, buys the rights to the lender's loans and homeowners start sending their checks to a new address. But experts say that isn't always the case -- and with so many companies going under, thousands more consumers are facing the problem head-on today. Homeowners who don't prepare themselves when they hear their lenders are in trouble will likely end up with a lot less hair before all is said and done.
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"Once a company announces that they're going into bankruptcy, customer service calls may go up fivefold or tenfold, with people being concerned calling in. With the turnover in the customer service and collection areas, it's very difficult," says Ted Jadlos, a principal with Phoenix Capital Inc. The Denver-based investment banking firm helps lenders evaluate, buy and sell mortgages and the rights to service them.
"You're dealing with people who are working in a very stressed environment," he adds. "People will sort of slip through the cracks."
In good economic times, problems don't pop up that often. Most borrowers make their payments on time and most lenders can earn enough money to stay afloat because consumers are refinancing and buying homes at a relatively decent clip.
Beginning in the second half of 1998, however, the lending climate started turning hostile. Interest rates began climbing, sapping demand for refinance loans. Russia's default prevented many subprime lenders from packaging and selling off their loans as readily as they had before. Without being able to "securitize" their loans, they couldn't find money to make new loans as easily. When companies securitize loans, they hold on to a portion of their risk, too. Since many had bent underwriting rules in an overzealous effort to boost volume, those companies are now facing rising losses from defaults.
As a result, several lenders who focused on home equity, debt consolidation and subprime lending went belly up last year and earlier in 2000. United Companies Financial Corp. filed for bankruptcy at the beginning of March 1999. ContiFinancial Corp. and Empire Funding Corp filed this May. Even companies that didn't go bankrupt ran into significant problems. First Union Corp., which bought The Money Store in 1998 for $2.1 billion, announced in June that it was essentially giving up on the company and shutting it down.
Flirting with disaster
"The reasons why different lenders got into trouble are really a host of things," says Shiv Rao, vice president at Moody's Investors Service. The New York lending analyst says major problems included lax underwriting, overpaying mortgage brokers and other third-party originators for their loans, and failing to have enough money on hand in case securitizing stopped being an option.
When lenders go under, creditors typically try to recoup some of their money by liquidating the bankrupt companies' assets. One such asset is the servicing rights that lenders usually hold on to when they securitize mortgages. The rights allow them to collect payments from customers and market additional products to them. Attorneys and investment banks retained by the bankrupt company and its creditors get together, figure out what those rights are worth, then take bids from other companies interested in buying them.
If the process goes smoothly, borrowers continue to send payments to the old lender until the new entity takes over with little trouble. They don't see any of the back-room brawling and shouldn't need to do anything more than change the address on their payment envelopes. Yet snafus abound, and thousands more borrowers than before are facing bankruptcy-related problems because so many of the subprime industry's former high-flyers have gone out of business.
Borrowers feel the bite
Take William Mueller, a 40-year-old customer service manager from Tonawanda, N.Y. In August 1998, he borrowed just over $19,000 from United. Since then, he has made his payments on schedule. But in the wake of the company's bankruptcy filing, he says he has spent hours arguing with them over questionable fees, tardy statements and on-time payments United deemed late. The company is in the process of selling its servicing rights to EMC Mortgage Corp., a division of the Wall Street investment firm Bear, Stearns & Co.
"I do not know what sort of people who UC Lending is used to dealing with, but we are people who are trying to pay our bills without going bankrupt," Mueller writes in an e-mail about his situation.
"It seems that whenever someone else sees that you are down, all they want to do is kick you," he adds. "Now I really can see why some people just go belly up without trying."
An attorney handling United Cos.' bankruptcy case didn't return calls for comment.
Proof of payment -- a borrower's best friend
Though borrowers can't just take their loans elsewhere or stop paying them when their lenders go bankrupt, they can take steps to protect themselves once they find out their lenders are having trouble. Mueller, for one, has been sending in payments "return receipt requested" and saving bank statements and canceled checks. That way, he has proof his payments were received on time.
"You might make a call thinking you have something resolved and then the problem pops up again," says Jadlos, the investment banker. "All of a sudden you get a late fee and you know you sent your payment in on time. It's a headache and nightmare for you."
Still, some say the problem isn't as bad as it's made out to be. Russ Munsch, an attorney with Munsch Hardt Kopf & Harr, P.C. in Dallas who represents Empire Funding, says the company's 80,000 or so borrowers shouldn't run into a lot of trouble. He points out that Empire received authority from the bankruptcy court to provide bonuses to employees willing to stay on through the servicing transfer process in order to minimize any problems.
"Usually there is no change from the borrower's standpoint," Munsch says. "They'll simply be notified to send payments to a new P.O. box or new address and there should be no perceptible change."
Nevertheless, borrowers dealing with bankrupt lenders may want to practice a little Boy Scout-style preparation.
"You need to be prepared to take responsibility to make sure those payments get in and get resolved. You need to budget more time for problems that come up," Jadlos says. "You really have to buckle down."
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