Is Your Mortgage in Trouble?

Your lender may have disappeared but (sorry) your mortgage isn't going to. Here's what does happen—and why you should worry

by Maya Roney

By the time American Home Mortgage officially filed for bankruptcy on Monday, Aug. 6, its shareholders had lost nearly everything and over 6,000 employees had lost their jobs. But the company's borrowers now face yet another predicament: What will become of their mortgages?

In most cases of lender bankruptcy, nothing changes—at least not from the consumer's point of view. When a lender goes out of business, it sells its assets at a discounted price to another financial institution under bankruptcy court supervision and notifies the borrower about the new servicer. "The effect upon consumers is probably going to be negligible," says Ray Hooper, housing director for the Consumer Credit Counseling Service of Greater Dallas. "It's not going to make any difference at all to the performance of the loan."

No Way Out

If, like an increasing number of home owners around the U.S. today, you were struggling to pay your mortgage and thought your lender's bankruptcy status might give you a freebie, you're out of luck. "You must continue paying your mortgage payment," says Hooper.

Apparently, this is not obvious to all home owners, especially when they are already struggling to make their mortgage payments. "They might just be looking for a way out, and if they're under stress they might just go into foreclosure," says Hooper. "We deal with people like that daily. People will just assume 'Well, these people have gone bankrupt I don't owe them anything anymore.' "

There have been 925,986 foreclosure filings so far in 2007, and that number could exceed two million by the end of the year, according to Irvine (Calif.)-based Web site RealtyTrac. As more lenders go out of business and it becomes more difficult to qualify for a loan, foreclosures are expected to increase. RealtyTrac reports that for 2006 there were 1.2 million foreclosures.

Wait—Who Owns My Mortgage?

Truth is, your originator (the firm you got your mortgage from originally) probably doesn't own your mortgage now anyway. Most lenders package loans together in bundles and sell them to Wall Street banks, or to Freddie Mac (FRE) or Fannie Mae (FNM). These companies then often repackage the bundles and sell them on the securities market as mortgage-backed bonds.

But due to rising defaults amid a struggling housing market, banks don't want to buy certain risky mortgages from lenders anymore, which is one reason why American Home Mortgage and other lenders such as Onwit Mortgage Solutions, ResAME Mortgage, Mortgage Lenders Network, and New Century Financial have gone bankrupt this year.

Most of these fallen lenders catered to subprime borrowers, but Melville (N.Y.)-based American Home Mortgage specialized in adjustable-rate mortgages and Alt-A customers—borrowers unable to document their income who are considered riskier than prime borrowers but less risky than subprime.

Banks that lent American Home Mortgage money, which include UBS (UBS), Bear Stearns (BSC), and JPMorgan Chase (JPM), said they were cutting off the lender since buyers on the secondary market didn't exist anymore. "The whole process really shut down" says Stephen DeLaney, an analyst at JMP Securities in Atlanta. "There was no home for the loans." The company's ensuing bankruptcy confirmed fears that problems in the mortgage market had spread beyond the subprime market.