Heads Up: Banks use calculation to determine whether to foreclose or not

My last post about the foreclosure crisis, Heads Up: Foreclosure still a reality for many homeowners, was a reminder that foreclosure crisis is still not over for many homeowners and some of your neighbors. And it is about to get a little more real.

Banks make money by lending money. They do not make money by holding mortgages that are toxic, meaning they are not making them money. In fact when a lender holds a mortgage that is in default or a property they have foreclosed on it cost them even more money because the lender must hold in reserve the amount of the loan that is toxic.

For example, a large bank has a non-performing mortgage for $100,000.00. The bank owner of the non-performing mortgage has suddenly lost the ability to lend the $100,000.00 but also must keep an additional $100,000.00 in reserves. So in fact the bank loses the ability to lend $200,000.00. Not a good place to be so the lender sells off the toxic assets to another lender at dimes on a dollar and collects insurance from the government to make themselves whole again. Remember the 7 trillion dollar bank bailout and how quickly it got repaid?

The new loan holder is the one who usually moves to foreclose on the toxic asset. How the owner of the note decides to foreclose or in some cases short sale a home is based on a calculation called Net Present Value. The calculation is complex but in a nutshell gives a present value for an asset based on a number of factors. The calculation helps to determine whether or not a lender would make more money foreclosing on a house now, working with the homeowner to short sale a home, or ignoring the property so the toxic asset will be worth more as a non-paying toxic debt.

When the real estate market was terrible and the majority of homeowners nationwide were underwater, meaning their property was worth less than what was owed on it, it made sense for lenders to work with homeowners to short sale. The lenders would get back the money they lost through government and insurance programs and the homeowner would get out of a tight spot. The NPV calculation when the real estate market was bad, the past few years, showed it made sense to lose a little bit of money.

Now it does not.

The market is up and houses are no longer underwater, but there are still a number of homeowners who have not recovered from the drop and are still in danger of being foreclosed upon. Unfortunately for them the NPV calculation looks a lot different than it did just 12 months ago.

With the market up it is beginning to make sense for lenders to foreclose on properties in default. Around the country the short sale and loss mitigation centers lenders put together are being consolidated and closing up. Short sales are a less attractive option for lenders when they can foreclose now, get cash for their toxic assets and move on.

With values up and a majority of buyers paying cash for property, the turnaround time to get toxic assets off their books and free up the ability to lend is proving too big a carrot.

So things are changing again and the foreclosure trend is changing with the times. Many think for the worse.

Next time, I will be talking to a couple of people trying to navigate through the new foreclosure environment and their take on what’s happening.

If you have any other questions, or want to share your story, please reply to this post, contact me via my website, my facebook page, or on Twitter @AmericaFoy.