If the Great Recession taught us anything, it’s that institutions can go under if they’re in enough financial trouble. In fact, more than 500 banks have failed since 2009.
Fortunately, there are protections in place to safeguard mortgage borrowers in the event of a lender or bank failure. Generally, if your loan has already closed and been funded, it shouldn’t be affected if your lender or servicer were to file for bankruptcy or go out of business.
What happens to your home loan after closing
To understand why you’re safe if your lender closes or goes bankrupt, first consider what happens to your mortgage post-closing. There’s a good chance the financial institution that lent you the money — also known as the mortgage originator — no longer holds your loan.
“Many borrowers get their home loan from a local bank, credit union or area lender and assume that the loan will always be owned by that bank or lender,” explains Robert Taylor, owner of The Real Estate Solutions Guy, a real estate investment company based in Sacramento.
“While it’s true that some smaller banks, commonly known as portfolio lenders, will keep home loans considered low-risk, there are very few banks that actually have sufficient funds to make more than a few loans,” Taylor says.
Consequently, originators sell their loans in what’s known as the secondary market, bundled in pools and typically unloaded to government entities like Fannie Mae and Freddie Mac. Within this market, your home loan could be sold two or three times in the first four months of its creation.
Once it’s sold, your loan will be managed by a mortgage servicer, the entity that receives your payments and either keeps the money because it owns the loan or sends your payment to the loan’s owner.
“Sometimes the bank that originated your loan will also be the servicer of your loan, even after it is sold,” Taylor says. “This can leave borrowers convinced that their loan is still owned by a local bank, even though it’s probably been bought by a third party.”
When a bank or lender is in trouble
Because of the way your mortgage is handled after closing, if your lender goes bankrupt or out of business — whether it be the company that originated the loan or a third party that later bought it — it should have no impact on you or your loan.
“The borrower is never informed about the lender’s financial problems,” explains Christopher Burgelin, owner of We Buy Houses Fast, LLC, in Austin, Texas. “If the bank’s charter is in jeopardy, the bank’s insurer or regulatory agency will step in to take over. This takeover typically ends with the FDIC inducing another lender to take on that bank’s loans.”
If your mortgage were to be taken over by another bank or lender, the servicing of the loan would become the new owner’s responsibility. Generally, the servicer or institutional investor servicing your loan is unlikely to go bankrupt, notes Bruce Ailion, an Atlanta-based real estate attorney and Realtor.
“But if they get into trouble, they will sell your loan or servicing rights to someone else,” Ailion says.
If your loan servicer changes, you will receive a notification confirming the change from both the old servicer and the new servicer. This notice will include information on where to send your payment.
“Your balance will stay the same, and your amortization will remain the same,” Burgelin says. “Your responsibilities will remain unchanged. You’ll need to pay your mortgage on time, keep the property insured and make sure your taxes are paid.”
What if the bank goes bust before the closing?
You’re preparing to close on your mortgage, but learn that your lender or bank is in dire financial straits. Should you start sweating?
The short answer is no. According to Ailion, “any funds you have transferred to an escrow agent should be secure if your prospective lender gets into trouble, but you will have to find a new lender to get a loan.”
Typically, lenders cease to underwrite loans if they approach insolvency.
“Back in 2008, a few lenders did file for bankruptcy protection post-loan approval and pre-closing, and the borrowers on these loans had to scramble to move their loan to a new lender,” Burgelin recalls. “Thankfully, because most loans are typically underwritten by Fannie Mae, Freddie Mac or FHA guidelines, the appraisal you already had done can be shifted over to a different lender for the same loan type.”
What you can expect
Again, if your mortgage lender fails or files for bankruptcy, nothing should change for you personally. All of your loan terms will remain the same. Taylor cautions, however, that you will not get any advance notice that your lender is in trouble.
“They’re not going to tell you because that’s just bad for business,” Taylor says.
You might eventually receive mail explaining the changing of hands, though, says Ethan Taub, CEO of Debtry.
“It would be good practice to at least have a phone call with your new lender,” recommends Taub. “This way you can learn more about them and any changes in how they operate regarding receiving payments, making accelerated payments if you choose to do so, and other matters you have questions about.”
How to find out who holds your mortgage
If you’re unsure of who owns your mortgage, you can look your loan up online via Fannie Mae or Freddie Mac, call your mortgage servicer or send a written request to your servicer requesting the name of your mortgage owner. (Download a sample letter you can customize and send to your servicer.) The servicer is required by law to provide you, to the best of its knowledge, the name, address and telephone number of the party that owns your loan.