Montclair, NJ · Member since 2014 · 66 posts · 6 votes
Imagine a town with only one house and one bank. The bank makes a loan for $250,000 on a house in 2000 at 5% interest. Now by 2006 the house value has risen to $400,000. If the house is sold the bank naturally wants to get back the balance of its original loan, and make a new 5% loan on the house for $400,000. In this way it can increase its revenue by 60%. On the other hand say a bank made a $400,000 5% loan in 2006 but today that house has a market value of $250,000. If the loan were paid off and the bank lent $250,000 on the house at 5% its revenues now decrease by 38%. The point is the bank has an incentive to call the loan due on sale while the housing market is rising but has an incentive to keep its loans in place while the housing market is declining or so it would seem to me. Is this line of reasoning sound economics or pure nonsense?
Clinton, NJ · Member since 2014 · 6 posts · 2 votes
12y
Sound logic Robert, but you didn't consider the security interest of the bank. In the first scenario where the property increased in value from $250,000 to $400,000 the bank has very little default risk for their 5% revenue. In the second scenario where the property has depreciated well below the original loan amount the bank has a high risk of default for their 5% revenue. Financial institutions consider risk as well as return when making their lending decisions.
You probably already know that your hypothetical falls apart in a competitive banking environment. In that case there's little chance that the bank would get the new $400,000 loan. Unless they have a very high market share for the area, another bank will most likely get the loan. So instead of gaining revenue, they probably lose it.