If you buy a product that turns out to be defective, it's natural to take it back to the store and demand a refund. But what if instead of, say, a $50 pair of pants with bad stitching in the seat, you had purchased 30 years' worth of cash flow from a mortgage that turned out to have been issued to a deadbeat? That's exactly what happened to thousands of investors. And they, too, demanded a refund -- a mortgage put-back.
Warranties and Representations
Lenders can make a lot of money by issuing mortgages. For example, a 30-year mortgage for $150,000 at 6 percent annual interest will generate a total of nearly $324,000 in payments over the life of the loan. The catch, of course, is that the lender has to wait 30 years to make its money. So lenders commonly sell their mortgages to investors. The lender immediately gets its money back, plus a profit, and the investor gets the right to collect the payments in the future. As part of the deal, the lender attests that when it "originated," or issued, the mortgage, it verified that the loan was valid -- the borrower was qualified, the property was worth the amount of the mortgage, and so on. These promises are called warranties and representations.
When resold mortgages go bad -- borrowers start missing payments, or they flat-out default on their loans -- investors start poking around at the circumstances surrounding the origination of the loans. This usually involves having a lawyer demand copies of the original loan documents and other evidence. If their investigation reveals that a lender didn't perform the proper due diligence -- the legal term for ensuring that all the T's were crossed and the I's dotted -- then the promises made in the warranties and representations amount to fraud. When that's the case, the investor can demand that the lender repurchase the loan. The investor is putting the mortgage back onto the lender, giving us the name "mortgage put-back."
Claims and Litigation
An investor seeking a put-back starts by filing a claim with the original lender, requesting that it repurchase the loan. If that request is denied -- and, as you can imagine, many are -- the investor can sue. Put-back lawsuits became common after the U.S. housing market collapsed in 2007-08, as evidence mounted that originators had knowingly written mortgage loans for people who had no way of ever paying back the money, solely so they could resell those mortgages to investors for a quick profit. Many of the originators had disappeared, and others were barely solvent, so investors commonly got back pennies on the dollar or nothing at all. In other cases, courts rejected investors' put-back claims after lenders argued that they themselves had been defrauded by borrowers, who lied on their applications, so their warranties and representations had been made made in good faith and weren't fraudulent.
What It Means for You
Even if you've never missed a payment and have shown no signs of trouble, there's a possibility that your mortgage may get put back on your original lender. Originators don't sell their mortgages one by one; they sell them in batches. If your loan -- your good loan! -- was bundled with a bunch of bad ones, the investors may insist that the lender buy yours back, too. But don't worry. This means very little for you. No matter how many times your loan changes hands, the terms of the loan contract you signed remain the same. You might have to send your payment to a new address, but that's about it. It will also have no effect on your credit score. Your credit report concerns itself only with your own credit behavior, not that of your lender or its other customers.
- Fitch Ratings: The Impact of Poor Underwriting Practices and Fraud in Subprime RMBS Performance
- Forbes: Wall Street's New Nightmare - The Next Wave of Mortgage-Backed Securities Claims
- Birmingham Post: The Put-Back Problem - Financial Crisis Part 3?
- CNBC: Bove: Put-Back Apocalypse Could Cost Banks More Than $150 Billion