# Why are Mortgages not Mortgages?



## Purple (21 Feb 2011)

A mortgage, by definition, is a loan secured on “real” property.

Therefore the lender is securing the loan against the property in question. If the borrower cannot pay their debt then the lender can take ownership of the property. That’s how mortgages work; the property is the collateral and the lender cannot pursue the borrower for losses greater than the value of that collateral. That’s how it works in the USA (that’s how the lender can “hand back the keys”.

What we have is personal loans with property offered as part collateral but the bank shoulders no moral hazard in the case of asset depreciation. This encouraged banks to make loans against property when they knew it would be in negative equity within the term of the loan as they knew they could pursue the borrower beyond the value of the property. In other works they were (in theory) in a no lose situation.

This lack of moral hazard is one of the main reasons that our banks behaved in such a stupid fashion; the risk was not visible up-front. 

So my question; should the borrowers liability on a mortgage be limited to the market value of the property? In other words should they be mortgages?


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## Mpsox (21 Feb 2011)

Historically, one of the reasons banks did not give 100% (or 105/110%+) mortgages was to hedge against the risk of the property declining in value. There is no arguement that 100%+ mortgages often coupled by additional personal lending was a stupid move on behalf of the banks.

However, if the risk to the bank was greater, then that would imply that interest rates would be higher.


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## Purple (21 Feb 2011)

Mpsox said:


> However, if the risk to the bank was greater, then that would imply that interest rates would be higher.



or they would be more careful about what they lend against as much as who they lend to.
My point is that the current system dilutes and blurs the risk the banks is taking when it gives a mortgage


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## Brendan Burgess (21 Feb 2011)

Hi Purple

Whose definition of "mortgage" is that? We use the term loosely, but the legal definition is very specific and Irish housing loans are mortgages.

But your main point is, I think, that we should ban non-recourse lending. 

There are pros and cons. 

If you follow your logic to its extreme, we should ban all personal loans. We should only give out non-recourse loans. So overdrafts and personal loans would be banned. You would not be able to borrow to buy a car - although I suppose HP would be allowed. Extend it to companies and they would not be able to borrow at all except non-recourse against assets. 

There is nothing at all to stop a lender offering a non-recourse loan. Say Bank of Ireland decided in the morning that it would offer non-recourse loans. 


They would, lend only around 50% LTV
They would charge a higher interest rate
They would repossess a home as soon as the borrower missed a few payments
We are going through a rough patch at the moment. We have to make sure that we don't make it rougher by introducing some new restrictions. 

Brendan


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## Purple (21 Feb 2011)

Brendan Burgess said:


> But your main point is, I think, that we should ban non-recourse lending.


No, I am suggesting that mortgages should be non-recourse. Personal loans would, by definition, not be non-recourse.




Brendan Burgess said:


> There are pros and cons.
> 
> If you follow your logic to its extreme, we should ban all personal loans. We should only give out non-recourse loans. So overdrafts and personal loans would be banned. You would not be able to borrow to buy a car - although I suppose HP would be allowed. Extend it to companies and they would not be able to borrow at all except non-recourse against assets.


 Yes, that is taking it to its extreme. I don’t see why that should be the case.



Brendan Burgess said:


> There is nothing at all to stop a lender offering a non-recourse loan. Say Bank of Ireland decided in the morning that it would offer non-recourse loans.
> 
> 
> They would, lend only around 50% LTV
> ...


I agree that interest rates would be higher but it follows that prices would be lower since the price is set by the total repayment that the lender can make each month.
I don’t see why LTV’s would be as low as 50% but I agree that they would be lower, again not a bad thing.
I also don’t see why banks would rush to repossess as you suggest since they will have costs associated with such as action which would, by definition, not be recoverable from the borrower.

I don’t think it’s a good idea to make such changes universally compulsory in a depressed market but it shouldn’t be rules out in the longer term.


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## Jim2007 (21 Feb 2011)

Purple said:


> I don’t think it’s a good idea to make such changes universally compulsory in a depressed market but it shouldn’t be rules out in the longer term.



And who to you expect will finance this dream world???  The banks lend the money placed on deposit with them - after all that has happened, how many people do you think would be will to place their savings on deposit with an institution that has such an high exposure to the property market.... or do you expect the government to provide a guarantee?

The type of mortgage you have described is that currently offered in the US, but you have failed to take into account what happened over there.  Fanny Mae, Freddy Mac and MBS came into existence in the USA, because banks were unwilling to provide the financing required - and look what a mess that turned out to be!

Jim.


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## Purple (21 Feb 2011)

Jim2007 said:


> And who to you expect will finance this dream world???  The banks lend the money placed on deposit with them - after all that has happened, how many people do you think would be will to place their savings on deposit with an institution that has such an high exposure to the property market.... or do you expect the government to provide a guarantee?
> 
> The type of mortgage you have described is that currently offered in the US, but you have failed to take into account what happened over there.  Fanny Mae, Freddy Mac and MBS came into existence in the USA, because banks were unwilling to provide the financing required - and look what a mess that turned out to be!
> 
> Jim.



Fanny Mae, Freddy Mac came into existence because of the policies of the US government during the great depression. Banks were unable to lend so the government underwrote everything (The start of big government in America and the beginning of the end of the American economic powerhouse). 

I'm in favour of banks shouldering their own moral hazzard and anything that shows that risk up front makes it easier for them to do so. I have no problem with people taking out personal loans in order to buy a house (which is what they do now) but many people, stupidly in my opinion, didn't get that their exposure went beyond the value of the property they purchased. No adult should make major financial decisions with the idea in the back of their mind that someone else will provide a safety net.

Anyway, it's a question, not a policy document from The Purple Party.


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## Brendan Burgess (21 Feb 2011)

Sorry Purple, that was a typo - I had realised what you meant. 

What if someone borrows from their bank to set up a business venture? If the venture fails, they should not have to repay the loan? 

if the car value falls below the amount of a loan outstanding on that car, they should just give back the car? 

As I said earlier, if any bank wants to provide non-recourse lending, they are free to do so.

But they should not be banned from providing recourse lending.


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## Purple (21 Feb 2011)

Brendan Burgess said:


> Sorry Purple, that was a typo - I had realised what you meant.
> 
> What if someone borrows from their bank to set up a business venture? If the venture fails, they should not have to repay the loan?
> 
> ...


Brendan, I'm looking to think this one through, I'm not proposing anything at this time.
But to answer your questions;
If someone borrowed for a business venture which was secured against X then X is all they should lose if things go pear-shaped. As long as the bank is fully aware of what the venture is and what X is, and have charged accordingly, then what's the problem?

On the car example; that happens already. It's called lease-purchase and the borrower pays more to share the risk with the bank.


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## Brendan Burgess (21 Feb 2011)

Purple said:


> Brendan, I'm looking to think this one through, I'm not proposing anything at this time.
> But to answer your questions;
> If someone borrowed for a business venture which was secured against X then X is all they should lose if things go pear-shaped. As long as the bank is fully aware of what the venture is and what X is, and have charged accordingly, then what's the problem?
> 
> On the car example; that happens already. It's called lease-purchase and the borrower pays more to share the risk with the bank.



Hi Purple

I think you are missing the point of "security". It's a comfort to the lender - that is all. 

If I borrow from a bank for a business without security, I must repay it all. You are suggesting that if I borrow with security, that my loss is limited to the security. 

The car finance shows the problem with the suggestion. In a lease-purchase, the bank buys a car and leases it to a customer. The bank owns the car not the customer. But the law allows for non-recourse lending i.e. lease purchase and recourse lending, normal car loan. It's the exact same for houses. recourse lending should not be outlawed for a house or for a car.

Brendan


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## Purple (21 Feb 2011)

Brendan Burgess said:


> Hi Purple
> 
> I think you are missing the point of "security". It's a comfort to the lender - that is all.
> 
> ...



As long as the lender charges more for the extra risk it is now sharing what's the problem? 
Would recourse lending have to be banned in order to have non-recourse lending? It is not a case of pricing according to the hoe the risk is being shared?

Comfort for the lender has led the lender to ignore that they are still shouldering a moral hazard. This is particularly the case with residential mortgages on a PPR since that PPR probably represents the vast majority of the borrower’s assets so if they can't pay their mortgage they have very little left in reserve. Basically the recourse element is a fig leaf for the lender to cod itself that they will not be left exposed if the asset value collapses.


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## Bronte (22 Feb 2011)

Purple said:


> . I have no problem with people taking out personal loans in order to buy a house but many people, didn't get that their exposure went beyond the value of the property they purchased.


 
Do not understand this?  It seems to me that during the tiger people bought thinking that property would only go up.  They compounded this madness by borrowing additional money for furniture, gardens etc and then to top it off borrowed more for lifestyle.  

The banks also thought that property was only going up and they were the 'experts.'   It was a no lose situation for everybody.  

But both the borrowers and the banks have lost.  The banks are having to write own a lot of debts and write off a lot of interest so they are paying.  Anglo is going to be wound down.   

The only reason banks haven't collapsed, is the government has decided they are too big to fail.  Otherwise they would have collapsed.


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## Purple (22 Feb 2011)

Bronte said:


> Do not understand this?  It seems to me that during the tiger people bought thinking that property would only go up.  They compounded this madness by borrowing additional money for furniture, gardens etc and then to top it off borrowed more for lifestyle.



My point is that the mortgage debt is secured against, but not limited to, the value of the property. Therefore it's a personal loan. If you took out a personal loan for €300'000 and couldn't repay it the bank could still go to court and take your house to pay the debt. The notion that mortgages are any different is an illusion.
As I said above the banks perspective the fact that they can go after your other assets if after repossessing your house and selling it your mortgage is still not cleared. This gives the bank a false sense of security since if a lender gets into a position that their house has been repossessed there is very little chance that they will have any other assets.
The illusion that they would be also to recover loan values above and beyond the market value of the property encouraged banks to lend recklessly as it blurred their risk.


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## csirl (22 Feb 2011)

> The illusion that they would be also to recover loan values above and beyond the market value of the property encouraged banks to lend recklessly as it blurred their risk.


 
I'm not sure that even if the banks were limited to the value of the property, that they still wouldnt lend recklessly. Look at the HMO buy-to-let fad in the UK. Banks routinely gave out mortgages based on 'yield' (i.e. the amount of rent the landlord hoped to receive once the property was converted to a HMO), rather than the value of the property. In may cases, the mortgages were up to 150% of the value of the property, yet in the UK, the bank can only recover the value of the property.


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## Bronte (22 Feb 2011)

I seem to be missing the point somewhat.  A mortgage is different to a personal loan because it is secured against an asset.  By having the mortgage on the property no other creditor can take the value of the asset only the bank.  That is the reason for mortgages.


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## Purple (22 Feb 2011)

Bronte said:


> I seem to be missing the point somewhat.  A mortgage is different to a personal loan because it is secured against an asset.  By having the mortgage on the property no other creditor can take the value of the asset only the bank.  That is the reason for mortgages.



Ok, they are a preferential creditor when it comes to the house but the individual is still personally liable for the full amount of debt outstanding.


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## Purple (22 Feb 2011)

csirl said:


> yet in the UK, the bank can only recover the value of the property.


 I wasn't aware of that.


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## Sunny (22 Feb 2011)

No, mortgages in the UK are mainly recourse mortgages like here.


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## Sunny (22 Feb 2011)

Purple, you mentioned moral hazzard in your OP with regard to the banks. The same exists with regard to borrowers and non-recourse mortgages. If we had non-recourse mortgages, people in negative equity now would have an incentive not to pay their mortgage. They would simply hand back the keys knowing that the bank can't come after their other assets (doesn't work as simply as that of course).


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## Purple (22 Feb 2011)

Sunny said:


> Purple, you mentioned moral hazzard in your OP with regard to the banks. The same exists with regard to borrowers and non-recourse mortgages.


 True. I'm just talking this through. Would you agree that the more the risk is shared the better it is generally? 




Sunny said:


> If we had non-recourse mortgages, people in negative equity now would have an incentive not to pay their mortgage. They would simply hand back the keys knowing that the bank can't come after their other assets (doesn't work as simply as that of course).


Agreed. Knowing this would it not be the case that banks would be more careful about lending in the first place?
In reality if a borrower cannot pay their mortgage the chances are that in most cases they will not have enough assets or income to cover the shortfall?


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## Purple (22 Feb 2011)

Sunny said:


> No, mortgages in the UK are mainly recourse mortgages like here.



I thought that was the case.


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## Chris (22 Feb 2011)

Purple said:


> True. I'm just talking this through. Would you agree that the more the risk is shared the better it is generally?



I would generally agree with this statement, but I don't think that non-recourse loans would have had much of an impact on the risks banks took during the bubble, especially given the "consensus" that house prices only go up.

The biggest factor that led to higher risks being taken by banks is that the people that gave them the money in the first place did not fear loss of investment. That goes for small depositors and large scale bond investors. Prior to the crisis there was an explicit guarantee for deposits up to €20k, but there was also the implicit guarantee from the precedence of past international bailouts and the existence of the lender of last resort. These implicit and explicit guarantees meant that depositors and bond holders were not worried about what the banks were doing with the money, as there was a back stop to the downside risk. Were there no guarantees then those providing the funds to banks would have paid more interest to what was being done with their money and would have asked for higher interest rates the higher the risk was.

Bottom line I think that you are right about risk being shared decreasing risk being taken by banks, but the banks will take as much risk as their money suppliers will allow them get away with.


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