The recent wildfires in Los Angeles destroyed more than 16,000 structures, including thousands of residences. In addition to the personal tragedy of losing a home, the crisis raises a difficult financial question: What happens to a mortgage when the house is gone?
For borrowers, one part of the answer is simple: Losing the house doesn’t mean they no longer have to pay for it.
“Sadly, they still have a mortgage,” Seth Sprague, director of mortgage banking consulting services at Richey May, an accounting and advising firm in Englewood, Colorado, told American Banker. “The borrower has signed up for debt, and they have to pay it off.”
Beyond that, the story is complicated for both the borrower and the bank. For the lender, the destruction of the house means much of the collateral for the loan is gone, and insurance suddenly plays a much more important role. For the borrower, forbearance and other resources may be available, but only if they communicate with their bank or mortgage servicer.
“The first thing a borrower should absolutely do is contact their servicer,” Sprague said. “The bad outcomes that you typically hear about are when you don’t have the borrower working with the mortgage servicer in concert.”
What happens to a house-less mortgage is up to whoever owns the debt. In some cases, that’s the bank that originally loaned the money, but more often it’s a non-bank mortgage servicer that bought the mortgage after closing. In 2022, non-bank companies owned the servicing rights on 54% of mortgage balances, according to the
Either the bank or the servicer will typically follow the guidelines of
“When you start talking about Fannie and Freddie … it becomes very prescriptive,” Sprague said. “There’s a loss mitigation waterfall. You’re going to follow what the investor-slash-guarantor tells you.”
Both Fannie and Freddie have longstanding policies for how to give homeowners relief when misfortune strikes. In most cases, the prescription is some form of forbearance, delaying or modifying the mortgage payments.
After the fires in L.A., Fannie Mae
“Our policies are available to any disaster where Freddie Mac is the investor on the loan,” Ben Gottheim, vice president of servicing policy at Freddie Mac, told American Banker. “Loss mitigation is available to anybody for any reason they have a hardship, whether their home is destroyed, whether they lose their job, etc.”
Banks offer relief
Separately, individual banks and local officials have collaborated to help tide over Californians who lost their houses. In January, Gov. Gavin Newsom said five banks — Bank of America, Citi, JPMorgan Chase, U.S. Bank and Wells Fargo — had agreed to provide at least 90 days of forbearance and 60 days of protection from eviction or foreclosure. Eventually this list grew to include 270 banks, credit unions and other lenders.
“After so much trauma, we hope this deal will provide thousands of survivors a measure of relief,” Newsom said in a
Then Newsom went a step further: On Wednesday, he
Some banks have developed their own assistance programs. East West Bank, which has dozens of branches in the L.A. area, offers a policy that CEO Dominic Ng calls “Skip a Pay”: Homeowners affected by the fires can skip a mortgage payment and pay it up to a year later — without accruing interest or hurting their credit score.
“The whole idea is that during the fire, they need to focus on all the other things,” Ng told American Banker. “They need to make sure that their families are safe. … They should not be wasting time to deal with East West Bank.”
But to take advantage of such policies, borrowers first need to let their bank or mortgage servicer know they need the help.
“The worst thing that happens is you get a borrower who doesn’t engage with their servicer, and therefore the servicer gets very limited as to what they prescribe,” Sprague said. “The earlier you interact with the servicer, the more options that are on their waterfall.”
Insurance is key
Once the house is gone, so is much of the collateral for the mortgage. But the bank still has leverage, as long as the homeowner is properly insured. That’s because to cash an insurance payment, typically both the homeowner and the mortgage servicer need to sign the check.
“The money just doesn’t go directly to the borrower,” Sprague said. “The servicer has to sign off on it as well.”
For that reason, adequate home insurance is extremely important for both the borrower and the servicer. The homeowner needs the insurance to cover the cost of either rebuilding their home or buying a new one. The bank or servicer, meanwhile, needs to cover the value of the mortgage if it’s suddenly lost from their portfolio.
“If there isn’t insurance in place, and it’s a portfolio loan, you’re taking the loss,” Sprague said. “If, ultimately, you don’t know who’s on the hook, it’s the servicer.”
Here again, the Fannie and Freddie guidelines come into play. To receive the agencies’ backing, lenders and servicers must make sure the property is thoroughly insured. Typically, that means requiring the homeowner to sign up for an HO-3 policy, which covers all disasters except for those explicitly excluded.
“Our guide outlines our property insurance policies including general property insurance requirements, minimum property insurance types and amounts, flood insurance, liability insurance for condo and co-op projects and more,” said Maeghan Gale, Freddie Mac single-family director of insurance policy. “These minimum insurance requirements help ensure borrowers are sufficiently covered and have resources to repair or rebuild their homes damaged by a disaster.”
The homeowner could also choose not to rebuild, or to move somewhere else, using the insurance money to pay off the rest of the mortgage on the former house. These decisions are left up to the homeowner. But under Freddie Mac’s policies, the required amount of insurance is based only on one calculation: how much it would take to rebuild the structure.
“Ultimately, it’s about a homeowner being able to recover in the face of disaster — being able to repair or replace their home,” Gale said. “It really drives our mission around sustainable homeownership.”