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What if my mortgage lender goes broke?

The recent turmoil in the financial markets has many readers a little nervous these days. Just reading the headlines can make you a dizzy. And with much of the bad news centered on the manic mortgage market, some homeowners are wondering: What happens if my mortgage lender goes broke?  Answer Desk, by's John W. Schoen.

The recent turmoil in the financial markets has many readers a little nervous these days. Just reading the headlines can make you a dizzy. And with much of the bad news centered on the manic mortgage market, some homeowners are wondering: What happens if my mortgage lender goes broke?

With so many lenders in financial trouble, I’m starting to wonder what will happen to my current loan if my lender declares bankruptcy.  I’ve been assuming that the lender would have creditors and that they would acquire the lender’s assets, including its outstanding loans.  Is there a scenario where I would have to renegotiate my loan with a new lender?  Should I start looking into other lenders now and, if so, how can I know how solvent they are?
-- Kerri, Calif.

When a lender gets in financial trouble, it has a few choices. It can look for investors to put up more capital. If that doesn’t work, it can declare bankruptcy or sell itself another lender. Since the subprime lending mess began to spread late last year, dozens of lenders have been forced to chose one of these alternatives.

But it’s your solvency — not the lenders — that matter most to you.  If you’re a good borrower, with a good credit and payment history, your mortgage is the most valuable asset a financially troubled lender has. In some ways, they need you more than you need them.

In any case, the terms of your original mortgage, like many such contracts, are almost always fixed and valid no matter who holds the loan. (If you want double check this and see what happens if your mortgage changes hands, dig out the original document and read the paragraphs on “sale or assignment” of your loan.)

Even lenders in good financial shape routinely sell off the mortgages they write soon after you’ve signed on the dotted lines. The reason is that, in some cases, there’s more money to be made in upfront fees than there is in collecting monthly interest payments. By selling off your loan, the mortgage “originator” gets fresh capital to lend to the next borrower — and then collect another round of upfront fees.

One of the biggest buyers of mortgages is Fannie Mae (the Federal National Mortgage Association) which was set up by the government to create a market for mortgages, thus freeing up more capital to lend to new borrowers. In some cases, when the loan conforms to established terms and conditions, mortgages bought and sold in the so-called “secondary market” are guaranteed by the federal government.

So your mortgage is like any other bond issued by any other borrower — whether from General Motors or the U.S. Treasury. The value of the bond may change based on the risk that the borrower may not pay it back. That’s why some of the riskiest subprime mortgages are selling for much less that the face amount.

But the terms of your mortgage — like those of other bonds — are fixed in the original agreement. That’s also why — even if your lender goes broke — you’re still on the hook to pay it back to who ever buys it.

There is one way the mortgage mess could create headaches for borrowers in good standing. Back in the days when lenders held onto the mortgages they wrote, you could be fairly sure the lender you borrowed from would be the lender you would deal with over the life of the loan. With mortgages now routinely changing hands, that’s no longer the case.

So you may not get the same level of customer service from the buyer of your loan that you know and expect from the good folks at Main Street Bank and Trust that wrote the original loan. In some cases, the company “servicing” your mortgage — collecting your checks, managing your escrow account — may not even be the same company that owns your loan. If the company providing this service gets into trouble, the quality of that service could be affected: monthly payments not applied properly, escrow payments on your behalf like taxes and insurance not made promptly, etc.

Unfortunately, you can’t choose who owns or services your loan. If your loan servicing company mismanages your payments, you may be able to get help from the consumer affairs department of your state banking department or attorney general’s office. Chances are, if you’re having trouble, so are other customers.

Reading through the Retirement Planning article, I am reminded of an online retiree medical cost exercise I recently completed at a well known investment Co. web site. In summary, the calculator for total out of pocket medical cost outlay (husband/wife age 60, retiring at 63 and living to 89) came to $550,000. Even bare bones retirement will be out of reach for many. I think the boomers will be wearing the Home Depot orange aprons until they literally drop.
R. M. Wheaton, Ill.

We’re going to revisit this topic at in another retirement series later this fall, but one thing to keep in mind is the source of that $550,000 estimate. “Well-known investment companies” make their money by encouraging you to save and invest with them. We’re not saying it’s a bad idea to save and invest. And there no doubt about the huge medical costs retirees face in the last few decades of their lives. But the savings targets that some of these Web tools come up with are extremely conservative – to the point of overstating the problem.

First, you have to look carefully at the assumptions used in these Web-generated forecasts. The greatest single assumption — how long you’ll live — will have the biggest impact of any of the variables you enter into these savings calculators. But it’s also the variable that is impossible to predict. Many retirement calculators, for example, use an optimal life span as opposed to the more likely numbers found in the insurance industry’s actuarial tables.

It’s also worth considering that medical costs generally are almost impossible to predict. We may one day be able to analyze your genome and come up with a list of potential illnesses you may face in old age. But even then, the lifestyle choices you make will continue to have a big impact on your longevity and quality of life. Even if you somehow could magically predict how long you can expect to live, it’s tougher still to make an accurate forecast of the medical treatments you’ll need along the way.

There’s another alternative to saving up a half a million dollars to cover your health care costs: it’s called insurance. While it’s impossible to know what will happen to public health care insurance in the next 30 years, at the moment it looks like some form of public/private combination will prevail.  So-called “Medigap” plans cover out-of-pocket costs not covered by Medicare. “Long-term” plans cover nursing home care.

By saving your own fund to cover health care costs, you’re in effect “self-insuring” your future expenses. It may be a lot cheaper to buy insurance coverage instead.