Housing market woes: Prof says they should prompt legal reform

Real estate professor Andra Ghent’s study of historical mortgage laws and foreclosure statistics shows that state laws vary greatly and, when laws require lenders to work through the court system, foreclosure processes tend to drag on and on. Such delays can hobble housing-market recovery. In fact, it’s happening now and, according to Ghent, now would be a good time for market troubles to kick-start legal reform of mortgage law across the United States.

Anyone who’s ever ripped a bandage off a tender sore knows that, sometimes, it’s best to get things over with quickly. The same might be true for battered housing markets, according to Andra Ghent, assistant professor of real estate at the W. P. Carey School of Business.

Ghent’s study of historical mortgage laws and foreclosure statistics shows that state laws vary greatly and, when laws require lenders to work through the court system, foreclosure processes tend to drag on and on. Such delays can hobble housing-market recovery. In fact, it’s happening now and, according to Ghent, now would be a good time for market troubles to kick-start legal reform of mortgage law across the United States.

Courting trouble

If there is one thing Ghent wants people to understand about today’s mortgage laws, it’s this: ”They’re not well suited to today’s environment,” she says. “For one thing, we have a nationally integrated mortgage market. Some 80 percent of mortgages are getting securitized by Fannie Mae or Freddie Mac, so unless you think the 50 states are different in some major sense, why would you have 50 different sets of mortgage law?”

And yet, we do. Why? Because the laws that currently exist are what Ghent calls “historical accidents.”

According to her, most of today’s laws evolved by happenstance. “It’s not so much that each state made a conscious decision to design their mortgage laws in the most efficient way possible.” Often, she explains, laws evolved as a result of some individual judge’s decision rather than statutory intent. Or, they developed as one state tried to emulate another, assuming that the model state had it right in the first place.

The random development of mortgage laws is all the more disconcerting when you consider another reality. “These laws are very old and extremely slow to change,” Ghent notes. In fact, her research traces laws back to 1863 for 37 states. Among them, only 11 states changed their foreclosure proceedings substantially between Civil War days and 2008. In the states for which Ghent had more recent data, similar inertia prevails.

Meanwhile, a handful of crucial characteristics distinguish mortgage laws among the states. One, and perhaps the one with the biggest impact, is whether courts are involved in the foreclosure process. “Foreclosure is much slower in states that require a judge’s approval for a foreclosure,” Ghent writes in a paper titled “America’s Mortgage Laws in Historical Perspective.” That condition, called judicial foreclosure, may not be bad, and many would argue it’s good for borrowers. “During The Great Depression, foreclosure rates were lower in judicial states than non-judicial ones,” she explains.

Still, there is a potential downside, Ghent points out. Historically, Fannie and Freddie have not charged a different guarantee fee from one state to the next, she notes. Given all the issues they’ve experienced in our recent housing crisis, they’re starting to talk about charging higher fees for certain states. “That means borrowers will need to pay more for their mortgages,” Ghent says. “Costs will be passed through.”

Dollars and differences

Which states would see costs rise? New York and New Jersey are two with laws on the books that delay foreclosure by requiring lenders to prove loan delinquency in court and, in both states, foreclosure rates still exceed national averages. A November, 2012 article in The Street noted that while the national average for foreclosure is now around 4 percent, the rate in Northern New Jersey is 8 percent and downstate New York has a 7 percent foreclosure rate. Both of these states are among the few where Fannie and Freddie are proposing a bump in guarantee rates. In both states, the backlog of foreclosure properties threatens housing-market rebound.

In Arizona, however, foreclosures are relatively quick. Although the state suffered mightily when the housing market first tanked, foreclosure rates now are under 3 percent and housing prices are up 20 percent year-over-year. “In New York and New Jersey, prices are down 0.4 percent and 1.7 percent respectively over the same period,” noted writer Shanthi Bharatwaj in The Street on November 30, 2012.

Still, Ghent wouldn’t be surprised if Fannie and Freddie raised loan guarantee fees in Arizona, too. That’s because Arizona is a “walk-away” state, which means that even if a lender fails to recover the entire loan amount in a foreclosure sale, the borrower isn’t on the hook for the remaining dollars owed. That means if a loan amount due is $200,000 and the bank only gets $150,000 in a foreclosure sale, the bank can’t sue the borrower for that extra $50,000. Unlike Arizona, most states do give lenders that kind of recourse should the foreclosure sale fail to pay off the entire loan.

Another area where state mortgage laws differ is in redemption rights, which specify procedures and time periods during which borrowers can buy back the property that has been foreclosed upon. According to Ghent, these rights harken back to the days of when people borrowed a little money on big estates in non-liquid real estate markets. So, even though borrowers were in a positive equity situation, they could still lose the property outright and completely through foreclosure.

Today, most people take on loans for homes – not massive estates – and real estate markets are liquid enough that these homes generally can be sold as long as the loan isn’t upside down. “Redemption rights seem really outdated,” says Ghent. She sees little harm in letting them go. It would simplify things for national mortgage lenders.

So would reining in state differences related to title versus lien theory. In title states, lenders retain the property title until the loan is paid off. In lien states, borrowers own the property, and lenders only have an interest in it if the borrower defaults on the loan. In reality, these differences have little impact on the balance of power between the lender and borrower, but they do require different paperwork, which complicates legal compliance for the national lenders.

Ultimately Ghent advocates national mortgage laws, a position that has been pursued by lawmakers at least four times since 1925. What’s more, Ghent asserts that now is the time to make national laws happen, and the window of opportunity may be closing fast.

“Nobody is going to pay attention to these laws five years from now. When the housing crisis is over, nobody is going to care,” she says. “If we’re going to make a change it should happen now. That may help out 20 or 30 years down the road.”

Bottom line

• Mortgage laws vary in the U.S. and states with laws requiring judicial foreclosure proceedings are seeing delays in housing-market recovery.
• Other differences in state mortgage laws can impact the complexity of servicing laws throughout the nation.
• The U.S. could simplify legal compliance for lenders by implementing national mortgage laws.
• Mortgage laws are slow to change, but now, while housing-market troubles have our attention would be the time to give it a try.