Just wanted to get your thoughts on why the repossessed collateral of banks (properties / vehicles) from defaulting clients are sold for lower / bargain prices? Does this mean they are substandard? Or banks just want to get rid of the properties to recover whatever portion of borrowed amount?
St Scho-lehiyala (verbal question from one of my talks)
Hi St. Scho-lehiyala,
First of all let me congratulate you for your question. Either you had some experience with a bank, maybe as OJT, or you’re really observant and insightful. Either way, kudos!
Now to your question, here are two perspectives which I think influence the banks in selling repossessed assets / collateral for lower prices than its perceived value. Surely, there are other considerations at play, but I would think these two carry big weight.
Because. They are sold lower precisely because they are repossessed or second hand, at least to a consumer’s point of view.The property or vehicle is no longer brand new. Let us face it, for the same amount, say PHP1M, a consumer would prefer a brand new house than a pre-owned house. Or a vehicle for that matter. Also, since someone else previously used it, new buyers might wonder why it was repossessed to begin with.
Could it be that the previous owner just really had a credit problem, or was the house haunted? Or was the car flooded / damaged etc? Not necessarily. But these uncertainties may put pre-owned properties at a disadvantage compared to brand new ones. So selling it a (steep) discount seems like a good proposition. It may not be brand new, but it was barely used. It is in good condition, very low mileage, well maintained, and best of all, sold at a lower price. Sounds like a good deal right?
Let me explain the concept of Loan-to-Value (LTV) ratio of banks for secured loans such as home loan or car loan. Banks do not lend 100% of the appraised value of the collateral, they usually put a cap to it, like 70% or 80%. This cap is the LTV ratio requirement. So if one is borrowing money to purchase a PHP1M car, the bank will just lend PHP800k or 80% of the value. The remaining PHP200k will have to be shouldered by the borrower as cash out / equity / down payment or whatever you call it.
Financially, this further covers the credit risk of the bank since the value of its security or collateral is higher than the amount it risked through the loan.
Psychologically, this supposedly should make the borrower more responsible in handling his/her loan since s/he is already a part-owner of the property. S/he already made a cash out so supposedly s/he should not default on the loan, otherwise the collateral will be repossessed by the bank and borrower effectively loses not just the property but also the money s/he used shelled out for equity. This LTV gives the banks a margin to sell the repossessed property at lower prices, precisely because their exposure is at most 80% only of the original price. Or exposure could be much lower if previous borrower was able to repay some amortizations of the loan.
Considering repossessed properties for your next house or next car can be a good deal. Just be sure that you still assess (or with the help of experts) the value and condition of the property, and not get too excited with the bargain price that the bank offers. There are good finds to be found in repossessed properties. Goodluck!