Bank Failures
A number of banks have been shut down by the FDIC this year including:
- First National Bank of Nevada
- First Heritage Bank of Newport Beach, California
- Netbank
- Indy Mac Bank
Most of the problems plaguing these banks have to do with loaning money to people who couldn’t pay it back. At one point, loaning money based on equity in a house was seen as a safe investment because house prices kept going up.
This is how most debt consolidation loans operated. People would take out a loan secured by the equity in their house to pay of unsecured debt. Banks could offer lower interest rates on debt that was secured by the equity in a home than unsecured debt. Since people expected the pricing of houses to keep going up it wasn’t uncommon for the value of the house to be overstated. Even if the value wasn’t overstated, the ease of getting a loan helped drive the house prices higher because there were so many people trying to buy.
Now that the value of these homes are dropping, people who took out debt consolidation loans backed by their house may be in some serious trouble. For one thing, they may not be able to sell the house without paying off the debt consolidation loan. This isn’t a problem if they are able to sell the house for the amount it was valued at when the debt consolidation loan was created, but if they value has gone down, they may find themselves in a situation where they can’t sell their house without bringing a significant amount of money to the table in order to sell.
Another potential problem is that the bank that issued the debt consolidation loan may have written provisions for this type of situation that allows them to demand payment if the value of the house falls below a certain point. In this case, people may find themselves in a lot of trouble because they have a large loan coming due with no assets to pay it off.
People who used debt consolidation as an easy way out without seriously adjusting their financial discipline may find themselves in a worse situation than they started in.