The topics covered on this page may include legal and regulatory developments affecting loan origination and mortgage creation, consumer protection, and enforcement of creditors’ rights. This page may also note key developments in some areas of law that are closely related to housing lending and necessary for development of a sound housing finance market, such as regulation of financial institutions, mortgage securities, and market participants, and are covered in more detail on other topic pages of this site.
Current laws and regulations of interest will be noted mostly on the individual country pages, but new laws and regulatory acts of particular significance may be noted here as we become aware of them, along with proposed or ongoing legal reform initiatives in various countries. The emphasis will be on issues in emerging mortgage markets, but developments in and materials from developed markets will be covered for the lessons and models they may provide.
As with other theme pages on this site, and because of the rapidly developing legal environment in many countries today, this page would benefit from advice and materials from readers in all of the countries Hofinet seeks to serve; all are encouraged to send updates on their legal regimes along with laws, regulations and policies newly adopted or under consideration.
Legal and Regulatory Issues in Housing Finance
Most housing loans are secured by mortgage of the home constructed, acquired or improved with the proceeds of the loan. While there are other forms of housing lending–housing microfinance, for example, which appears to be developing rapidly today–and other forms of loan security, these appear to comprise a relatively minor part of the total volume of housing lending. Indeed, most banking regulators insist on high-quality collateral for housing loans, even more so today as the effects of the 2007 mortgage market crisis in developed economies continue to be felt. Accordingly, the essential laws of housing finance are concerned with the creation and enforcement of mortgage liens, and the depth and breadth of housing finance markets in countries may be related to the nature and quality of their laws for establishing and enforcing creditors’ rights under mortgages.
Theory of Mortgage Collateral
Laws and regulations can be either incentives or disincentives to lending and borrowing. The theory of collateral is that by providing an efficient means of recapturing an investment, the costs and risks of housing lending are reduced. In particular, shorter time periods and greater certainty in realization of collateral eliminates risks such as lost interest and loss of principal from deterioration in collateral value due to, for example, unpaid taxes or lack of property maintenance. Simplification of enforcement procedures also may tend to reduce transaction costs. Reduction of transaction costs and financial risks means greater proceeds from sale of collateral, which benefits not only the creditor, but in theory the debtor also. Reduced costs and greater certainty in enforcement are believed to result in lower risk premiums in interest rates, and greater willingness of creditors to make more credit available for housing construction and acquisition, either going deeper into the socio-economic strata or offering larger loans.
Some Empirical Evidence
Arriving at compelling conclusions regarding the relationship between the efficiency of enforcing creditors’ rights and the availability and cost of credit has not been easy. Finding data that permit cross-country comparisons, defining the appropriate indicators, and controlling for the host of external variables that affect credit markets and interest rates are only a few of the problems. Nevertheless, there is a body of empirical evidence that the theory is correct, and that an efficient system of creditors’ rights increases societal welfare. Modern studies have suggested a strong relationship between the quality of laws, the efficiency of law enforcement concerning creditors’ and contract rights and the availability and cost of credit to businesses and households. Moreover, while much of this research initially focused on the laws themselves, it has become clear that the quality of the laws and quality of enforcement can be independent variables and that good laws will have more effect when they are efficiently enforced. A few examples of these findings include:
·In a 2004 study of loans to legal entities in 48 countries ranked on the basis of the strength of creditors’ legal rights, Bae and Goyal found that banks lend more, over longer terms, and charge lower rates on loans to borrowers in countries where creditors’ rights are well protected and efficiently enforced. The study suggests that although strong creditors’ rights in the laws decreased interest rates, more efficient enforcement of contracts in the courts not only decreased interest rates but increased loan size and lengthened loan maturities as well.
·In a 1990 study of mortgage loan enforcement in the United States, Clauretie and Herzog found that the characteristics of the mortgage law had an effect on the losses incurred by mortgage creditors. Creditors’ losses were lower in states that allowed non-judicial enforcement of a mortgage and personal judgments against borrowers for the amounts not repaid from sale of the mortgaged property, and higher in states that established long periods for debtors to redeem the property after foreclosure sale. Similar studies in the U.S. market have found that long redemption periods result in higher average interest rates on all mortgage loans in the jurisdiction in which the long periods apply.
·In a 2005 study using a sample of loans in 43 countries, Qian and Strahan estimated how various bank loan terms–including interest rates and maturity–may be affected by a country’s legal and institutional characteristics. They concluded from their study that where creditor protections are strong, bank loans tend to have longer maturities and lower interest rates. ·In a 2008 study that focused on legal development in 12 Eastern European countries in transition from socialism, Haselmann, Pistor and Vig showed that the strength of laws on collateral, including the ability to efficiently pledge and register a pledge of real and personal property, significantly affected the quantity of credit available in those countries, and suggested that the increase in lending was greater for ordinary households than for business enterprises. The authors speculated that this result arises because more efficient collateral laws allow creditors to compensate for the lack of clear information regarding the credit-worthiness of individual households.
·In a 1991 study, Xavier Freixas showed that in Europe the average cost as well as the duration of judicial procedures required to repossess pledged assets are inversely related to the amount of funds available to finance consumption and housing acquisitions by households.
·In a 2003 study for the World Bank, Laeven and Majnoni investigated the effect of judicial efficiency on banks’ interest rate spreads for a large cross-section of 106 countries. They defined the interest rate spread as the difference between the average lending rate of the banks and the average interest rate the banks paid their depositors. They compared the interest rate spreads with standard indicators of judicial efficiency and the quality of the rule of law, including an index that takes into account the time taken to deliver judicial decisions. They found that after controlling for a number of other country characteristics, judicial efficiency, in addition to inflation, is the main determinant of interest rate spreads across countries. That is, the perceived performance of the judiciary as measured by various indicators contributes directly to the difference between the interest rate banks borrow at and the rate they lend at. Poorer performance on the judicial efficiency indicators led to higher relative interest rates. They concluded that in addition to improving the overall macroeconomic climate in a country, judicial reforms, through better enforcement of legal contracts, are critical to lowering the cost of bank credit for households and firms.
·Studies indicate that even within a single country, financial outcomes vary across regions that have the same laws but different court efficiency. Bianco et al. (2005) found that in Italian provinces with longer trials or larger backlogs of pending trials, credit is less widely available than elsewhere in Italy and the interest rate spread between bank lending rates and deposit rates is greater.
Relationship of Length of Trials to Amount of Credit Granted by Banks in Regions of Italy
Source: Magda Bianco & Tullio Jappelli & Marco Pagano, 2001. “Courts and Banks: Effects of Judicial Enforcement on Credit Markets,” CSEF Working Papers 58, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 09 Apr. 2002.
As a general proposition, there appears to be a consensus that poor legal fundamentals–in particular the inability to create and enforce a mortgage lien in a reasonably efficient and cost-effective manner–leads to increased risk of lending, higher risk premiums in loan interest rates, higher transactions costs and markets that are both smaller and shallower in terms of income strata served. Regardless of the statistical proofs, it seems self-evident that any rules or procedures that increase the risks and costs associated with lending will have a price, and the question is, what form does the price take, and who is paying it? The price may be in higher interest rates or less credit than would otherwise be available, or may be in encouraging the use of alternative systems of securing credit that provide fewer formal legal protections to debtors.
Lack of legal guidance
There are several ways in which inadequate legal regimes may affect the breadth and depth of housing finance markets. One has been lack of clear legal guidance for lenders in the laws of some emerging country markets. Lenders are reluctant to be pioneers in situations where the laws are unclear and there is lack of legal precedent, as is the case in many emerging markets. This concern seems to be decreasing as better mortgage laws are adopted and experience with housing finance is gained by lenders, borrowers and courts. Nevertheless, in new markets some ambiguities persist. Typical areas of ambiguity may include grounds for default and enforcement of claims, judicial discretion to suspend or refuse execution, permitted defenses to lender’s claims, legal priorities among parties, and obtaining orders of eviction and possession of mortgage property.
Delays and non-judicial process
A main problem may be long delays and high costs in realization of creditors’ rights. Delays are a function of the laws and often of enforcement of the laws by the courts, which may be reluctant to enforce claims against residential property and inclined to tolerate long delays on procedural grounds. This is true not only in emerging markets but in many developed markets as well. It is perhaps noteworthy how many countries of the EU, for example, specifically allow courts to suspend execution of a mortgage for a period of time, in their discretion, for the benefit of the borrower on grounds of social protection.
Long delays in collection have in some countries led to use of alternative devices to secure housing loans and avoid the complexities and inefficiencies of mortgages. These alternatives include lease-purchase and installment sales contracts, where the title to the property remains in the name of the lending institution; or equitable mortgages or mortgage by deed, where the borrower assigns the deed to the lender; personal guarantees; and use of back-dated personal checks, which could in earlier times expose a borrower to criminal penalties in the event of default (and which have been outlawed today in many counties). Mortgage alternatives may in many cases be more efficient for the lender and arguably have increased the volume of housing lending in some countries, but they are not necessarily good for borrowers, as they often lack the basic protections of borrowers’ rights and equities that are found in mortgage laws. Despite its obvious drawbacks, one thing that can be said of mortgage law is that it provides significant legal protection to the rights and interests of debtors that other forms of security may not.
An important approach to procedural delay has been to remove mortgage enforcement from the courts through non-judicial enforcement procedures such as lender power of sale or fiduciary trust arrangements. In the former the lender itself can proceed to sell a property without going to court, subject to statutory rules, and in the latter an independent trustee or fiduciary such as a notary or bailiff can take action on behalf of the lender without court action. Understandably, non-judicial enforcement of mortgages is a matter of some controversy in many countries, and even in the United States a large number of states will not allow it. In some places there may be a sense that banks are predatory and will institute unjustified enforcement actions to profit from resale of the property, though there has been little evidence of that, and much more evidence that taking and selling property is the last resort for most lenders and in fact often results in significant losses. (The recent mortgage market crisis in the United States may throw a different light on this issue by suggesting that actual predatory behavior of lending institutions is irrelevant if the lenders are negligent and even recklessly indifferent with respect to their loan underwriting practices.)
Similarly, the laws of most countries today require some sort of public auction sale of mortgaged property, based on the expectation that public sales are more transparent and in theory should result in market prices for auctioned property. In fact the evidence to support those propositions is also lacking and good arguments can be made that private sale through normal market mechanism may provide benefits to both lenders and borrowers.
|2014||2014 Financial Stability Report|
|2014||IMF Selected Issues Report|
|2013||Land and Buildings Taxes Act|
|2013||Chile: subsidies, credit and housing deficit||Fernando Garcia de Freitas|
|2013||Property Taxes in Selected Asian Countries||Ministry of Finance of the Republic of Indonesia Directorate General of Fiscal Balance|
|May 2012||Danish Covered Bond Handbook||Danske Markets|
|January 2012||A Guide to Global Covered Bond Legislation||Anne Caris, Caspar Cook, Alexander Batchvarov|
|2012||The Interaction of Monetary and Macroprudential Policies||Heedon Kang|
|2012||FSB Principles for Sound Residential Mortgage Underwriting Practices||Financial Stability Board (FSB)|
|2012||America’s Mortgage Laws in Historical Perspective||Andra Ghent|
|2011||Regulation Z: Truth in Lending (Ability to Pay)||Jennifer J. Johnson|
|2011||Law 189-11 Mortgage Legal Code||National Congress of the Dominican Republic|
|2011||Cyprus Mortgage Legal Information||Doros Theodorou|
|2011||The Missing Foundations of Housing Finance: Incomplete Markets, Fragmented Policies and Emerging Solutions in Guatemala||Mario Cuevas, Sigfrido Lée and María Isabel Bonilla|
|2011||A Resource Guide to Housing in South Africa 1994-2010||Kate Tissington|
|2011||Housing and Real Estate Finance in the Middle East And North Africa Countries||Oliver Hassler|
|2011||Thematic Review on Mortgage Underwriting and Origination Practices||Financial Stability Board (FSB)|
|2011||Retail Product Development and Governance – Structured Products Review||FSA|
|2011||Uganda Guidelines for Micro-credit||Bank of Uganda|
|2010||Setting the Framework: Connecting Public and Private Sector||Marja Hoek-Smit|
|2010||Regulation of Foreign Currency Mortgage Loans: The Case of Transition Countries in Central and Eastern Europe||Hans-Joachim (Achim) Dübel and Simon Walley|
|2010||Report to Congress on the Root Causes of the Foreclosure Crisis||Christopher E. Herbert|
|2010||SAFE Act: Final Rule||John C. Dugan|
|2009||HOUSING SUPPLY IN ALGERIA: AFFORDABILITY MATTERS RATHER THAN AVAILABILITY||Tahar Bellal|
|2007||Housing Finance Gap Analysis in Francophone Sub-Saharan Africa||Canada Mortgage Housing Corporation|
|2007||Mortgages in Transition Economies: The Legal Framework for Mortgages and Mortgage Securities||European Bank for Reconstruction and Development|
|2005||Housing Finance: New and Old Models in Central Europe, Russia, and Kazakhstan||Edited by József Hegedüs and Raymond J. Struyk|
|2004||Creditor Rights, Enforcement, and Bank Loans||Kee-Hong Bae and Vidhan K. Goyal|
|2003||Does Judicial Efficiency Lower the Cost of Credit?||Luc Laeven and Giovanni Majnoni|
|2002||Courts and Banks: Effects of Judicial Enforcement on Credit Markets||Tullio Jappelli, Marco Pagano, Magda Bianco|
|December 1999||Mortgage Market Reform in Egypt||Nathan Associates Inc.|
|1997||Legal Determinants of External Finance||Florencio López de Silanes|
|A Decade of Regulation in Paraguay (Spanish)||Jorge Luis Schreiner Marengo|
Stephen B. Butler is a Principal Research Scientist in the International Projects Department of NORC at the University of Chicago.He has advised international donor agencies and ministries, central banks and regulatory commissions in 30 transitional and developing countries in 5 regions, focusing on land reform and administration, housing and housing finance, and mortgage market development.