Are You Off the Hook for Your Loan if Your Bank Goes Belly Up?

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As the banking industry continued to hemorrhage in 2008, 25 U.S. banks failed. Among them were Washington Mutual and IndyMac, the first- and third-largest bank failures in U.S. history, respectively, but there were also scores of smaller regional banks throughout the nation.

According to the American Bankers Association, 98% of the nation’s 8,500 banks are considered well capitalized, making the chance of any one bank going bankrupt highly unlikely. Still, bank failures increased markedly in 2008 and will likely continue in 2009 under current economic stresses.

Most U.S. banks are insured by the Federal Deposit Insurance Corporation (FDIC), so in the case of a bank failure, any one individual’s bank deposits, up to $250,000 at any individual institution, are protected by the FDIC. (The coverage limit, which Congress increased last year due to the banking crisis, will remain in force at least through December 31, 2009, but may then revert back to $100,000 if Congress takes no further action.)

But what happens to your mortgage, car loan or credit card account if the bank that loaned you that money goes out of business? Could their loss be your gain?

Unfortunately, you are still on the hook for any and all debt you have incurred. If your bank fails, you’ll need to pay close attention to how you handle your loan payments in the ensuing months.

Here’s what to do:

1. Continue making your monthly payments on time, and as usual. Don’t fool yourself into thinking that the upheaval of a bank failure is an excuse to skip payments. Doing so will only hurt your credit, as late payments will be reported to the credit bureaus; if you skip payments on a credit card account, late payments could also increase your interest rate.

In the event of a bank bankruptcy, the FDIC will assume control of the bank until it finds a stronger bank willing to buy the assets of the failed bank. Because your loan is a legal contract, neither the FDIC nor any bank that buys the failed bank can change the terms of your loan, and you, as borrower, are still bound by the same terms to repay the loan as originally agreed

Credit card account terms, however, are not fixed like a house or car loan. If another bank purchases a failed bank’s credit card accounts, the new bank is not required to honor the interest rate or other terms of the original account, like annual fees, over-limit fees or late fees. Still, it’s in the new bank’s interests not to reshuffle the deck, because making radical changes could trigger an exodus as the old bank’s credit card customers reject the new terms en masse

In short, most credit card holders won’t notice any changes in how they can use their cards, but if you could be considered a borderline credit risk by the takeover bank, it’s possible they’ll change your account terms or even close it. Cardholders with a high credit score have the least to worry about.

Financial planner and author Suzie Orman advises keeping copies of your cancelled checks and loan payments for at least six months following the takeover of your bank to avoid potential problems if your payments aren’t recorded during the transition. (If that were to happen, you would then need to check your credit report to ensure the takeover bank has not reported your payments as late or delinquent.)

If you’re already delinquent on your mortgage payments, there’s a chance that bank foreclosure proceedings will be temporarily stopped, giving you a chance to negotiate an agreement on payments that help you stay in your home.

2. Read your mail and any correspondence concerning your bank’s failure. It’s important to be aware of any changes regarding to whom you write your checks and where you mail them, but continue writing your checks and mailing payments to the same address until you are notified otherwise. Be careful, bank failures represent another opportunity for scammers looking to steal money from unsuspecting bank customers by concocting bogus emails or websites redirecting your payments.

Check the FDIC website for specific details on how accounts and loans at each of the banks that failed in 2008 are being handled.

Although the FDIC insures bank accounts, experiencing a bank failure when your personal savings are involved is still unsettling, and most customers would prefer to avoid that possibility altogether. To protect yourself:

1. Be sure your bank is FDIC-insured.
2. Be sure that your deposits at any one bank, whether they’re certificates of deposit, money market accounts or savings and checking accounts, don’t exceed the $250,000 FDIC coverage limit.
3. Be cautious about opening any one-year or longer-term CDs that exceed $100,000 before December 31, 2009. Unless Congress acts to continue the extension of the FDIC coverage limit to $250,000, a CD over $100,000 may not be fully insured after that date.
4. Check the strength of any institution with which you’re considering banking by visiting an online bank rating service. Although many bank failures can’t be anticipated, understanding the overall strength of your bank can be helpful in assessing the risks.

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