How the Credit Crunch Can Affect You
The so-called credit crunch has struck panic not only among stock market investors but even among those who have invested in far less risky assets—like money market funds and the biggest financial investment for most Americans: their homes.
As President Franklin Roosevelt said in the depths of the Great Depression, "there is nothing to fear but fear itself." Like most emotions, fear eventually gives way to reality that, while scary, is far less so when you understand the facts.
Here are a few that may help soothe concerns that the world is falling apart:
Is my money safe in a money-market account?
Although your money isn't federally insured to up to $100,000 as it is in a bank or savings and loan, money market funds are allowed to invest only in safe, short-term securities like U.S. treasury bills, which, of course, are backed by the government. To be sure, they can also hold mortgage-backed securities, but only investment-grade AA- and AAA-rated bonds, like those from federally sponsored issuers like Fannie Mae and Freddie Mac. And even then, they can't hold more than 5 percent from a single issuer. The plain fact is that, to date, no individual investor has ever lost money in a money market fund. And although some institutional investors may find their access to funds temporarily cut off—as recently happened to commodity traders who kept their cash parked at Sentinel Management Group's money fund—the chances that money held in individual accounts at major institutions like Vanguard, Fidelity, or TIAA-CREF is at risk remains remote.
What about my mortgage. What happens if my lender goes belly up?
Even if you took out a mortgage from your favorite longtime bank down the street, chances are that your mortgage has long since been resold and packaged into a mortgage-backed security, so whom you borrowed the money from originally is largely inconsequential. If whoever owns your loan today goes under, your loan is considered an asset that will be divvied up by a bankruptcy court and distributed to the company's creditors. Even then, those creditors have to honor your loan contract to the letter. They can't call in your loan early, nor change the terms unless you default.
So what happens if I default?
First, take a deep breath—long, one hopes, before you're in danger of defaulting. The biggest problem for people in over their heads on a mortgage is ignoring the issue until it's too late to do anything about it. Most creditors want anything but to get stuck with yet another foreclosed property on their books, and they're increasingly willing to change the terms of a loan to help prevent that. So before your first late payment, call your lender and start negotiating for better terms. You may be surprised by what they're willing to do to keep you in your home.
But what if my mortgage totals more than what my house is worth? Aren't I just better off walking away?
Many homeowners who have fallen behind on their mortgages owe more they can get for their houses today. But like everything else, the housing slump, too, shall pass. Despite the miserable outlook over the next year or two, the fundamentals are on your side in the long run, thanks, in part, to demographic changes that will add more than 90 million Americans over the next two decades. Most of them will want their piece of the American dream, too. Your house may not be the cash machine you thought it was, but it's still likely to be a sound long-term investment. So unless you simply can't scrape the money together to pay the mortgage, you're better off sitting tight and riding out the storm than selling at a loss or, even worse, getting foreclosed on.
Just so I know the worst-case scenario, what happens in a foreclosure?
It's a long process, and it varies from place to place. But the basic chronology is that you fall behind on payments and become delinquent (usually after 90 days of nonpayment). Your lender then starts foreclosure proceedings, usually through the county public trustee, and if you don't pay up, the house is repossessed and you get evicted. (This process, too, can stretch on for six months or more.) Eventually, the county sells your property at a public auction. If no one bids more than is owed on the mortgage, the lender steps in and buys it for the cost of the outstanding mortgage, then tries to resell it. Yet even after the auction, most homeowners are allowed more time (usually another 75 days) to make good on the loan and buy the house back—plus interest and penalties.
And if I can't come up with the money to buy it back?
Then it's gone, your credit score plummets even further than it already has, and your chances of securing another home loan, auto loan, or even a credit card, are dramatically reduced—at least for the next seven years that the black mark appears on your credit history.