CONFIDENTIAL SETTLEMENT TERMSHEET AGREEMENT

The following are the binding, essential terms of a final settlement agreement between American Interbanc Mortgage LLC (“American Interbanc” or “AIM”) and the NovaStar Entities (NovaStar Financial, Inc. (“NFI”), NovaStar Mortgage, Inc., NFI Holding Corp. and NovaStar Home Mortgage, Inc. (“NHMI”)).  The parties shall have an obligation to negotiate in good faith toward mutual execution of a longer-form definitive agreement containing the terms herein.  If the parties are unable to achieve mutual execution of such a longer-form definitive agreement within seven (7) calendar days of mutual execution of this Confidential Settlement Term Sheet Agreement (“Agreement”), this Agreement shall be the final, binding settlement agreement between the parties.

1.           A petition for involuntary bankruptcy filed against NHMI by AIM and two other alleged creditors, Lucy Fredich and Richard Burden (“Fredich and Burden”) in the U.S. Bankruptcy Court for the Western District of Missouri, case no. 08-40245 (the “Involuntary”);

2.           An action by AIM against NHMI, and other defendants, pending in the Superior Court of the State of California, County of Orange, as case no. 02CC04857 (“California Action”), in which a judgment has been entered for AIM and against NHMI, and other defendants (the “Judgment”).

3.           Asserted claims by AIM against NovaStar Financial, Inc., NovaStar Mortgage, Inc., NovaStar Home Mortgage, Inc. and NFI Holding Corp. for alter-ego liability and fraudulent transfers (the “Alter-ego Claims”), the release of which the parties hereby acknowledge and agree constitutes good and valid consideration and more than reasonably equivalent value in exchange for the obligations of the NovaStar Entities pursuant to this Agreement.  (The NovaStar Entities dispute the Alter-ego Claims, and nothing in this Agreement is an admission of liability regarding such claims.)

4.           NHMI’s appeal of the California Action, pending in the Court of Appeal of the State of California, Fourth Judicial District, Division Three, as case no. G039165 (the “Appeal”).

5.           An action by AIM against NHMI, pending in the Circuit Court of Jackson County, Missouri, at Kansas City, as case no. 0716-CV28878 (“Kansas City Action”), to enforce the Judgment.

6.           A judgment entered in favor of AIM against NHMI, and other defendants, in the Superior Court of the State of Delaware, County of Newcastle, judgment no. 08J-01528 J-24-454 (“Delaware Judgment”), to enforce the Judgment.

b.           Pursuant to an agreement between the parties in the Involuntary, more than $50,000 has been deposited into a separate account of NHMI (the “Bankruptcy Account”).

c.           The parties now wish to settle all of the claims between AIM and the NovaStar Entities, including those asserted and threatened to be asserted in the Involuntary, the California Action, the Kansas City Action, the Delaware Judgment, and the Appeal.

(iv) Delivery to AIM of a written document evidencing that NFI's current indebtedness to Wachovia has been satisfied in full.

a.           The NovaStar Entities shall cause TWO MILLION DOLLARS ($2,000,000), plus all monies in the Bankruptcy Account, in good and available funds to be wired to AIM within ten (10) business days after notice of entry of dismissal of the Involuntary.

b.           If (and only if), between the date of this Agreement and June 30, 2010, inclusive (the “Back-end Period”), NFI’s market capitalization has reached NINETY-FOUR MILLION FOUR HUNDRED THOUSAND DOLLARS ($94,400,000) or higher (the Back-end Condition), and all of the following conditions are satisfied, NFI shall pay FIVE MILLION FIVE HUNDRED THOUSAND DOLLARS ($5,500,000) to AIM by wire transfer (the “Back-end Payment”):

c.           If all of the conditions in 2.b. above have not been satisfied on or before June 30, 2010, the Back-end Condition shall be deemed not to have occurred, and the Back-end Payment obligation shall expire.

Upon receipt of the payments set forth in Section 3.a. above and satisfaction of the conditions in Section 2.c. above, AIM, on the one hand, and the NovaStar Entities, on the other hand, hereby release and discharge each other from any and all claims raised or which could have been raised by either party against the other in the California Action, the Kansas City Action, the Delaware Judgment, the Appeal, and/or the Judgment or related to the subject matter thereof.  This release extends to and includes the Alter-ego Claims.  This release also extends to and includes claims by or against the parties’ predecessors-in-interest, successors-in-interest, and their current and former partners, affiliates, members, parents, subsidiaries, officers, directors and the agents, employees, representatives and attorneys of the parties and the foregoing.  The Parties further agree to waive the provisions of Civil Code §1542 (set forth below) and agree that this release shall also constitute a release of those claims otherwise covered by such section:

“A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor.”

In the event that (i)(a) any of the NovaStar Entities, including NFI or NHMI, files for bankruptcy protection – or an involuntary bankruptcy petition is filed against any of the NovaStar Entities, including NFI or NHMI – under either Chapter 7 or 11 of the Bankruptcy Code within ninety-one (91) days (the period for determining a preference under the Bankruptcy Code) of the date that AIM receives, and AIM’s bank accepts, the $2 million payment by wire transfer, or (b) any of the NovaStar Entities, including NFI or NHMI, files any other insolvency-related proceeding – or any other insolvency-related proceeding is instituted against any of the NovaStar Entities, including NFI or NHMI (i.e., assignment for the benefit of creditors) – within the relevant claw-back period (not to exceed one hundred twenty-five (125) days after the date that AIM receives, and AIM’s bank accepts, the $2 million payment by wire transfer) provided by such insolvency-related proceeding to avoid any transfers by the NovaStar Entities as a preference (“Preference Period”), and (ii) AIM is subsequently required to disgorge the $2 million payment as an avoidable preference in bankruptcy (a “Preference Contingency”), the parties’ release obligations pursuant to this Agreement shall not occur, and the parties’ obligations pursuant to Section 2.c. hereof to file the dismissals of the California Action, the Kansas City Action, and the Delaware Judgment, record the satisfactions of the Judgment, and deliver the mutual releases, also shall not occur.  In such event, the Preference Contingency shall be deemed to have occurred.  Otherwise, the Preference Contingency shall be deemed not to have occurred, and the Preference Period shall be deemed to have expired.  AIM covenants that it, John Michael Dannelley, and/or Mary Dannelley shall not cause a bankruptcy petition or any other insolvency-related proceeding to be filed against any of the NovaStar entities.  In the event that AIM breaches this covenant, the Preference Contingency shall be deemed not to have occurred, and the Preference Period shall be deemed to have expired.  Without limiting the generality of the foregoing, in the event that there is a bankruptcy filing as to one of the NovaStar Entities during the 91-day period referenced above in this Section 5 – or an insolvency-related proceeding during the 125-day period referenced above in this Section 5 – the parties' mutual releases hereunder shall not occur until after the later of (a) the end of the period during which there is a bankruptcy or other insolvency-related proceeding to avoid a preference under any federal or state bankruptcy or insolvency laws (or the end of the limitations period for filing such a proceeding if such a proceeding is not filed) and without the occurrence of a Preference Contingency; or (b) satisfaction of the conditions in Section 2.c. above.

Execution of this Agreement shall not void or supersede agreements entered into by any of the parties in connection with the mediation between NFI and AIM, including the Confidentiality Agreement and Agreement Not To Trade Upon Non-Public Information.

Except as may be necessary to enforce the obligations in this Agreement or make disclosures to NFI’s shareholders and lenders and the NovaStar Entities’ auditors, accountants, and lawyers, the parties agree to keep the terms of this Agreement strictly confidential.  The parties intend for this Agreement to be protected by the mediation privilege as well as the rules governing inadmissibility of settlement communications.  Nothing in this provision shall prohibit either party, including their officers, representatives and attorneys, from disclosing the terms of this Agreement (i) pursuant to a court order or validly issued subpoena, and/or (ii) as required by securities law and other applicable law.

The rights and obligations of the Parties pursuant to this Agreement shall be binding upon and shall inure to the benefit of the successors and assigns of the Parties.

This Agreement will be governed and enforced in accordance with the laws of the State of California, without regard to its conflict of laws principles.  The parties agree that any action for breach of this Agreement or to interpret or enforce this Agreement shall be brought in the United States District Court for the Central District of California, Southern Division (Santa Ana Courthouse).

In the event that any of the parties files a legal action to interpret or enforce this Agreement, then the prevailing party shall be entitled to reasonable legal fees, expert fees and costs.

This Agreement constitutes the entire agreement between the parties hereto pertaining to the subject matter hereof, fully supersedes any and all prior understandings, representations, warranties and agreements between the parties hereto, or any of them, pertaining to the subject matter hereof, and may be modified only by written agreement signed by all of the parties hereto.  No express or implied promises, inducements or agreements have been made by any party to the other except as specifically and expressly set forth within this Agreement.

This Agreement may be executed in counterparts.  Each counterpart shall be deemed an original, and when taken together with other signed counterparts, shall constitute one Agreement, which shall be binding upon and effective as to all the parties.  Signatures by facsimile and/or e-mail shall be deemed as effective as original signatures.