Lessons from the housing fallout

NEARLY EVERY day, it seems, we hear about the rising tide of homeowners who are losing their homes to foreclosure, and the identified culprit is usually the "predatory" lender. But there are simpler, less nefarious reasons why some consumers find themselves in this predicament. There are structural conflicts of interest in the real estate industry - conflicts that helped shepherd borrowers to all-too-predictable financial ruin. We should use the present crisis as an opportunity to correct them.

None of the customary participants in the real estate purchase and financing process - the realtors, appraisers, lenders, home inspectors, and bank closing attorneys - has an incentive to caution the buyer when he is buying too much house, or advise him that real estate does not always go up in value. None of the participants will suffer the consequences of a bad decision to the extent the buyer/borrower does, and most of them not at all.

When I refinanced my home loan a few years ago, I went to a large mortgage company for a 15-year fixed rate loan. A few days later the application materials arrived, filled out for a 30-year adjustable rate mortgage, not the 15-year fixed rate mortgage I wanted, and I notified the mortgage company of the discrepancy. A few weeks later, the paralegal from the lawyer's office called to schedule the loan closing. I asked her to confirm that the loan documents were in fact for a 15-year fixed loan. Guess what? They were all drawn up for a 30-year adjustable rate loan.

I don't think there was anything particularly sleazy going on. Interest rates were going down, everyone was busy refinancing, and this particular company didn't know how to do anything but a 30-year adjustable rate mortgage. Still, I resisted. They tried telling me that "underwriting" had determined I was not eligible for a 15-year fixed rate mortgage. I yelled at them. "Underwriting" reconsidered.

I was able to advocate successfully on my own behalf, but I've been a real estate attorney for over two decades.

I still remember my mother's reaction when I bought my first home 20 years ago in New London, Conn.: "You are paying what for a one-bedroom apartment?" She paid $12,000 for her four-bedroom house in 1964. Oh, and she still lives in it. But what about a less-experienced borrower - one who doesn't practice real estate law, or who doesn't have a mother raised during the Depression?

The person investing in your mortgage used to be a local banker; now your loan is more likely to be "securitized," and the risk passed on to an investor you never met.

Years ago, more buyers/borrowers had their own lawyer representing them in residential transaction. These days, the lender's attorney often handles the entire transaction, without a lawyer advising the buyer/borrower, to save on closing costs. The residential real estate bar has for too long looked away from this apparent, if not actual, conflict of interest. The seller's broker also "represents" the buyer in many cases. This "dual representation," now permitted for real estate agents, needs another look.

I've participated in hundreds of residential real estate closings, and rarely did the borrowers have a clue what the documents they were signing actually meant.

To take an example from trusts and estates law, a "self-proving will" requires two witnesses to swear that the testator understood the import of the legal document he signed. Perhaps a similar step is needed when a borrower commits to a mortgage loan.

That condo in New London, the one I bought 20 years ago, went "under water" less than two years after I bought it - meaning the mortgage amount exceeded the value of the property when the market tanked - and it stayed that way until 2004, when I finally sold it.

I was lucky - my income went up over the years and I was able to hold onto the property by renting it out (at a loss) for many years after I moved away. But if I had bought something bigger at the time and borrowed more money, as a lot of people advised me to do, I probably would not have been able to carry the loan.

"You are paying what for a one-bedroom apartment?" Don't you hate it when your mother is right?

Peter O'Connor is a Boston-based attorney whose practice focuses on commercial real estate and urban redevelopment. He can be reached at peter@pmolaw.com.