Foreclosure has become an outbreak affecting the entire United States of America. Realtytrac just reported in the month of April 2011 that one in every 593 housing units received a foreclosure filing. (N1) That statistic is for just one month! Some states such as Arizona, California, Florida, Michigan and Nevada continue to be plagued with an influx of homes falling victim to foreclosure or some other form of default. Each home that is a casualty to a foreclosure, short sale or even bankruptcy was collateral for the lender holding the promissory note. The consequences tend to come at a cost for the lender selling the property but a deal for the buying investor. The costs incurred and the losses experienced by the affected financial institutions has required ongoing evaluation of their business models to account for the realized risks that these foreclosures have caused. Governing financial agencies are implementing and enforcing new regulations to mitigate further losses for financial institutions, government sponsored agencies and ultimately protection for the consumer. The deficiencies caused by the outbreak are shaping a new environment for property finance.
Accounting for Loss
Before a mortgage loan gets granted to the borrower(s), the loan is underwritten and reviewed for potential risk of default. Policies, procedures and business models all are used by the lending company to mitigate excessive exposure to risk of default. The lender can offset the vulnerability to default by reviewing the collateral property value, requiring private mortgage insurance, charging a higher interest rate, or charging additional points. A combination of any of these options may also be considered when evaluating a risk assessment.
Historically borrowers that have at least 20% equity in the property are less likely to default on the loan. A property with less than 20% equity or a Loan-to-Value (LTV) greater than 80% on a conventional mortgage is required to obtain Private Mortgage Insurance or PMI as a condition to getting the loan. PMI insures the lender in the event of default.
A higher interest rate or points charged to the borrower can also help offset the risk of loss. Secondary investors such as Fannie Mae or Freddie Mac may charge a Loan Level Price Adjustment (LLPA) based on different levels of risk. These levels of risk include but are not limited to: credit score, loan-to-value, cash-out refinance transactions, and the type of property (i.e. manufactured home, investment property, or multiple units not to exceed four-units).
Causes for Default
Lenders review the applicant(s) to decide if they will qualify for the mortgage loan. This process known as underwriting, takes into consideration the borrower’s ability to repay the mortgage. The lender will look at the person(s) past and present credit history, employment history, and income to debt ratio to determine the loan repayment capacity of the applicant(s)....