Just a stupid question that ran through my head the other day. What happens with the loans when a bank goes under? Say I have a 200k mortgage balance and the bank that is holding that mortgage goes under. Does insurance kick in or will the loan be called in?
Hopefully my question makes sense
Banks don’t just disappear; they are taken over by other banks or a governing agency. Those agencies continue to run the bank and servicing the mortgages. If the bank is liquidated, your mortgage will be an income producing asset that has to be sold to another bank that wants the income from it. In other words they really want you paying your mortgage to that it can be sold as an asset. You and your mortgage are the good parts that every bank wants to buy. The mortgages that are not being paid on are the ones that no banks want to buy and the governing agencies end up taking on and working through as a loss.
So those of us that pay our bills will have our mortgages sold, but deadbeats that with bad credit that don’t pay their mortgages have a chance having it fall through the cracks? They may end up never having to pay the rest of their mortgage?
No, it won’t fall through the cracks. Whichever institution takes over the failed bank (FDIC if the bank was federally chartered) will manage the bank’s assets until they are sold. A defaulted loan will still trigger a foreclosure and the deadbeat’s credit will still be trashed.
They won’t get a free ride just because the bank went under. A foreclosure will haunt their credit report for the next seven years. They will lose their home. Property insurance and auto insurance premiums will get more expensive. Telephone and utility companies will require large deposits before they install new service. If they have a security clearance, it may get withdrawn or downgraded. They may be denied jobs because employers use credit score as a hiring criteria especially if the employee will be handling money or require bonding. Credit card interest rates will skyrocket on their existing accounts under the universal default provisions of the credit agreement. If they can qualify for a new mortgage in the next couple of years or want to finance a new car purchase, the interest rate will be prohibitively high.
True, they won’t have to pay the rest of their mortgage, but there won’t be a free ride.
Some mortgages that you get through smaller banks are in turn sold to larger banks anyway. For those loans that have been sold, would it even matter to that consumer if the small bank got taken over?
No, once your loan is sold you no longer have a relationship with the original lender unless they retained the servicing of the loan. Your loan documents likely have a clause stating that your loan might be sold and if so your obligation to pay transfers to the new owner.
The only insurance involved in a bank failure is the Bank Insurance Fund (BIF) which is administered by the FDIC and funded by payments from insured banks and thrifts. When a bank fails the govt steps in and either sells the bank to another bank or operates the bank under a new charter. The assets are written down to market value and if this is less than the liabilities then the BIF (balance about $52 billion) steps in to guarantee depositors accounts up to $100k. One problem faced with a bank failure is that even good borrowers often try to take advantage of the situation and stop paying their mortgages thinking they will somehow slip through the cracks. As previously stated this is not the case.