The Law of Mortgages - Part 1: History and Equity
The following is a rough transcript of this podcast episode together with sources imbedded as links:
My name is Nathan Green, and I am a practicing lawyer.
For most people the biggest contract they will ever sign is a mortgage. Biggest in terms of its physical length of the papers to be signed, biggest in terms of the length of time it will impact their lives, biggest in terms of the amount of money involved, and biggest in terms of its ups and downs, risks and benefits. There are people, lots of people, who made more from buying and selling real estate than they ever made from a job. And there are people who lost everything they had because of real estate downturns.
This podcast is the first in a multipart series on mortgage law. This installment is about the History of mortgages, in the second we will discuss how tiny twists of law can drastically impact mortgage lending, and the systemic dangers this causes, and in the third we will talk about the role of a lawyer and sharia lending.
We all understand the basic idea behind mortgages: you borrow money to buy a house, and if you don’t repay it the lender can take back the house, but mortgages are far more interesting than just that, and silently shape a great deal in society.
While we think we understand the basics the key, essential, terms of many mortgages are not understood by the people borrowing. I can’t tell you how often I deal with people caught off-guard by the terms of their mortgages – even though unlike almost any other contract they ever entered into, they had to have a lawyer advise them on the terms of their mortgage.
Yet the massive value tied up in our societies on mortgage lending, and the uniformity of their terms and logic, has shaped much more about western civilization than most people realize. For people these are rare contracts, for banks these are cookie cutter documents produced on mass. You take any mortgage contract template from a major lender and there are going to be billions and billions of dollars governed by that document.
For people mortgages are also a bit different than most contracts because they are tied up with hope, and dreams. The American dream is home ownership. A lot of people buy a house so they can start a family. And the one thing standing between people and that dream is signing on a line for a mortgage… who cares what the terms are… Sign your name, have the dream. So we have this combination, power, deep emotional need, and ignorance, that is a very dangerous mix.
My goal with this podcast is not to show you all the details of a mortgage, every mortgage is different, the law of mortgages is highly dependent on jurisdiction and even from one province to another in Canada the basic sceme of mortgage lending can differ in very important ways from the perspective of a person with a specific legal issue, and even if I knew all that and could explain it comprehensibly, you would be bored out of your mind. Rather I want to pull the devil from those details and show him to you. Because, more than anything else, this is NOT legal advice.
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Disclaimer
This is not legal advice
The information here in any form is for entertainment purposes only.
You should not rely on or take or fail to take any action based upon this information.
Never disregard professional legal advice or delay in seeking legal advice because of something you heard here.
This is not legal advice.
This is not legal advice.
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For some reasons money has always been viewed as a bit vulgar or taboo. You can ask a person what their occupation is, but not their salary. You can ask someone what their kitchen counter top is made of, but not what they paid for their house. You can ask a person how many children they have, but not their net worth.
In Roman times through to the Victorian era different classes were defined by how they made their money. The aristocrats made money from land, passive income, while the lower classes actually worked for a living. To be a land owner was seen as being better than an inventive farmer. And this was a view shared by the ancient Romans even before Christianity came to the empire https://en.wikipedia.org/wiki/Landed_nobility.
Imagine how monumental a change the last century has been to finally make the inventor great: the steve jobs, the henry fords, the Bill Gates, now have much more social status than the owner of the most real estate in New York (whoever that is). If you consider yourself someone who knows a bit about history ask yourself how many inventors carved their names into history. Prior to Alexander Gram Bell or Henry Ford how many inventors can you name? Not scientists like Galileo or Darwin but inventors. The guy who invented a better bucket, an inventive horse saddle, a better farm plow. The Romans built amazing water works and auquafers. Someone figured that out and I have no idea who he was but isn’t he more important that Steve Jobs or Bill Gates?
With the millennium a couple of decades ago people were doing a ton of top 100 lists and I remember that through history the number 1 invention was supposed to have been the printing press. Gutenburg invented it. Now, you would think, greatest invention in human history, the inventor should have been really, really, rich right? He went bankrupt trying to sell the thing.
There is of course some debate about whether this is a good thing or not. As a society you have choices about where power comes from in your culture. Religion? We explicitly ban that in our constitution. Honor? Nobility (blood)? Land? Money?
We might like to say that in our society power is controlled by the people, everyone has one vote, everyone has the same power. But to say everyone has power is to say that no one does. We might all have the same voting power, but clearly there are other kinds of power that exist and we do not allocate those equally. In addition to his vote, Bill Gates has a ton of other kinds of power coming from money, and celebrity. We have attempted to use economics as a proxi for merit and distribute power, not just economic power but also celebrity power, a social power of popularity, to those who have financial success. I imagine a old british woman wrinkling up her entire face when I say that and declaring money equaling merit “vulgar”. And she has a point doesn’t she. I think it is a bit vulgar that an investment banker should rub elbows with politicians at ten thousand dollar a head dinners. But then I also think its vulgar that someone should be able to rub elbows with politicians because they just so happen to be someone’s son.
Back to money though, because even today we still make moral judgments about people based on how they got their money. Caesar for example would have considered Hugo Chavez’s billionaire daughter as an aristocrat with pure money, while we would ask how a person can become a billionaire without having invented anything, or performing any obvious service to society, and would probably like to have some law enforcement agency do an audit to find out just where all that money came from.
Why does this matter?
Because the first person who proposed to borrow money, and secure repayment with title to land, must have been viewed as a lunatic. Imagine if you had a goose that not only laid golden eggs, it laid Fabergé Eggs that gave you fame, status, power, celebrity and money. You want to risk losing that goose to get some dirty money? Just be frugal, just live within your means! When a person wanted to mortgage their land they were risking everything. They risked their future income, their family legacy, their title, their social standing. It was… well almost unthinkable.
I have been trying to think of some kind of analogy for today. And they all fail somewhat. For example imagine there was some machine that would let you transfer your brain into Tom Cruise’s head, and let him put his in yours. Can you imagine him ever agreeing to that, no matter how much you paid him? I mean he is rich, and can make as much money as he wants with an afternoon’s work endorsing some product. He is famous, women probably throw themselves at him. His social status is such that if he wanted to run for political office he would easily win, or he could just get a meeting with any politician to have his views heard. Why would he possibly give that up for a million, ten million, a hundred million dollars? And even if he did, you would just ruin it. You can’t act. You can’t pull off what Tom Cruise does to make his money and you would rapidly fall from an A list, to B list, to Has-Been status if you took over his life. You might over-eat and not take care of your looks and they would quickly fade away. As land owners in ancient times you didn’t have to be attractive to get the social status or women. You didn’t have to be a good at anything to make money. Simply by owning land you had it all.
Which is, obviously, why it was such good security on the repayment of a loan.
Historically securing payment on a debt has been such difficult work that lenders have wanted the most punishing consequences for failure to repay. There were debt slaves, there were debtor prisons, loan sharks murder people for unpaid debts when there is no further legal remedy and payment seems unlikely. Being able to secure payment on your social status and future income seems par for the course.
For example there are media reports in the financial times that Chinese loan sharks are demanding nude photos of borrowers as collateral. Don’t pay and be shamed online and in your community. https://www.ft.com/content/cce6d400-32c6-11e6-ad39-3fee5ffe5b5b?mhq5j=e1 That is happening today. So obviously we still haven’t exactly figured out how to secure a loan to everyone’s satisfaction.
The proverbial pound of flesh. The more terrible the consequences for defaulting, the more pleased a lender is with its position.
Another thought will occur to you about borrowing in a class based society. Let’s say you are the upper crust of the society. Image is important, respect is important, social standing is important. Is there really a way for you to come out ahead by lending money? If you lend money and someone doesn’t pay you need to publicly resort to some deliberately nasty enforcement methods. Is that going to win you any points in social standing? Or let’s say you don’t enforce harshly enough and people start saying you are soft. Is that going to win you any points? Imagine you were the person publishing women’s nude photos when they didn’t pay their debts: huge, negative, social consequences to you. And let’s not forget that historically in the western world both Islam and Christianity have had prohibitions in place on the lending of money. So… who is doing the lending?
The people who made their money from lending have never been generally liked. There were also religious prohibitions on lending (see Christianity and Islam). So it was the outsiders, social, religious, cultural, that generally lend. https://en.wikipedia.org/wiki/Usury And sometimes they still pay the price for that historical stigma: *cough* The Jews * cough*.
Now of course there are innumerable counter examples. I don’t mean to say that insiders never lent. I just want to set things up so that when we talk about really old mortgage law you appreciate that there are probably a lot of reasons in the head of a judge of the day for him (and this is one of the situations where you don’t need to add a “or her” to the sentence), to dislike a mortgage lender.
In fairness to lenders, no matter how terrible the penalty for defaulting on a debt, people still do it. And for borrowers no matter how terrible the consequences, something makes them want to roll the dice on these gambles and risk not being able to repay.
With all the benefits of modern society, economics, credit checks, bankruptcy law (that effectively puts up all assets as security on debts), and driver’s licences to track a person no matter where they go, and an established western legal order, there is still a huge gap between the risk premium a bank wants for unsecured lending. So you can imagine, in ancient times without credit scores, without computer models, post-dated cheques, etc. etc., how much of an innovation it would be to be able to secure a loan against a piece of property.
However, no matter how serious the penalty for failure, eventually someone was going to fail to repay their loan and the lender was going to go after the land.
Old mortgages didn’t work the way ours do. With a modern mortgage you make a regular biweekly or monthly payment and the final payment is generally the same amount as the initial payment. In old mortgages you didn’t make monthly payments. They were much simpler. On day X you borrow a sum, 10,000 pounds say, and on a specified date in the future you had to pay another sum, 12,000 pounds say. You show up at a set place, at a set time, with a set sum of money, and mortgage is repaid. You don’t show up and you were in default.
Why did they work this way? Anyone with any experience lending knows that if you want to get paid you need to get paid every month. Whatever the borrower’s budget, they need to build the debt into their monthly payments. So was this malicious? Did lenders not want to be paid back? It certainly makes a default more likely. But have you ever tried to calculate your mortgage payments by hand?
Before I went to law school I was working in an engineering department, my undergraduate degree is in Aerospace Engineering. I considered myself something of an expert in mental math – for example I don’t have the multiplication tables memorized and instead solve multiplications in my head each and every time. The point is, when it comes to math, I am good.
And I can’t do basic mortgage math without a calculator. Right after law school I spent about two weeks studying mortgage prepayment rules and I tried to reverse engineer everyone’s formulas (with the assistance of excel). I got close, extremely close, but every single bank, had a few dollars variation from my calculations. They all rounded a bit differently for money, interest, and time. But really my take away from that experience is that if some guy, no matter how well educated, sits down with a pen and paper and tries to figure out his mortgage payments, he is going to fail. So maybe lenders of old England simply didn’t have the math skills to be able to do anything but a simple single payment.
So, for whatever reason mortgages used to be set up so that on some day, January 5th say, you borrow a set amount. And then on a set day, July 8th say, you have to repay another, larger, set sum. Fail to repay, and you lose your land.
Now I need to go on a bit of a tangent. The other week I saw a movie with some of my friends. Hell or High Water. It was a great movie. The premise is that these two brothers have a piece of land in Texas that the bank has a 30k mortgage on (borrowed to pay the medical bills for their dying mother that they desperately needed). The land sits on oil though and it is worth a hundred, a thousand, times what the mortgage is, and the bank knows this and is hoping to seize the property to make a fortune. If these brothers can’t come up with the 30K by the end of the week the bank will take the land. So the brothers decide to rob the bank and pay them back with their own stolen money. It is a great, fun, stick it to the system, movie, and no one feels terribly bad for the bank by the time its over.
The catch is though that this isn’t how things actually happen today. If you owe 30K on a property worth 3 million, 30 million, you just got to another bank and get another loan. In our system there are plenty of other lenders, and there is almost always a lender available, it just depends on how much they will need to be paid in interest. Today banks don’t really lend money hoping to be able to foreclose, they just want to get paid, not profit from seizing land. At least, general speaking, for various reasons, that isn’t how banks behave if for no other reason than you can just get a new mortgage with someone else if there is untapped equity in the land.
That wasn’t always the case though. There was a time when lenders could make a huge profit by foreclosing. And it was because of what we were talking about earlier, the social status land brought. It was like being a movie star to own a real estate, it was better than being a movie star. It was your ticket to fame, fortune, and status.
Imagine that you have made a fortune in business but are looked down on by the gentry of your country. You want to be a land-owner to get into their exclusive club, but they are not selling their land (because it is what gives them their status). So you simply can’t buy land. But what if you lend money secured by a mortgage hoping for a default? Get land through the back door as it were. You would also probably be a bit pissed off about the whole social arrangement, and after all you are a successful business man who knows not to over-pay when you don’t have to. So you can go ahead and lend the smallest amount possible. Who is the villain then? The evil lender, or the stuffy nobility that thinks it just deserves to be wealthy without contributing to society?
So… there is a failure to pay and both sides go to court. The lender wants the contract enforced and the borrower doesn’t want to lose the family estate and become a commoner.
The judge is himself a member of British high society, respected, powerful, probably hob knobs on the weekends with the borrower, their friends, their relatives, their patrons.
And I’ll give British aristocrats something else, they understood how to play the game. Anyways, while I don’t do litigation, I do often work in transactions where the bank is trying to take a house. The first and most important question is “do you have enough to pay back the bank?” See these aristocrats they might not be able to gather up the money in time to make their payment on time, but when they are in default and they go to a lawyer and get told that they are about to lose their family legacy, they find a way, and show up in court with every penny the lender is owed.
Or perhaps those are just the cases that made it into my textbooks. Either way, the history of this area of law is a history of aristocrats who made it as difficult as possible on judges to give the lender what they wanted.
So, the typical case, was for the plaintiff we have a contract, a clear breach of its terms, and a clear entitlement in the contract to take a piece of land if there is a breach. But… the plaintiff is a money lender, he is an undesirable of one kind or another socially, religiously, or simply morally – trying to lend ten dollars on land worth 100. And we have the defendant, who clearly broke his contract, but may be young and imprudent, or deeply apologetic, with social status and standing, about to lose absolutely everything, probably going to lose a lot more than they borrowed, and right there, that day in court, they have the money they owe…Every cent.
The court’s decisions were so biased towards borrowers, for such a long period of time that the term for a mortgage borrower that developed was “the spoiled children of equity”.
Courts would let borrowers repay their debts beyond any kind of reasonable limit, eventually up to the very moment a binding commitment for the resale of the land was made. Courts required onerous procedural hoops to be jumped through by lenders – regardless of what their contracts said – for them to get clear title.
Without violating the sanctity of debt and the requirement it be repaid, and without prejudicing a bonafide arms length purchaser for value, courts went whole hog for borrowers.
To give you an example of just how deeply this bias went, and there is a qualification I am going to put on this that I will come back to in a moment, but for the moment here is the example. Imagine you are a smart lender and you have been thwarted time and time again trying to take land when a contract was violated. So you give it some thought and you realize that the courts hate to force transfers of land because of its special place in society. In fact when someone sells their land, the purchaser has to abide by the contract EXACTLY in order to acquire the land. If courts are fanatic about ensuring someone not lose their land, there is a ying and yang to that, brutal enforcement of agreements for the sale of land, and onerous restrictions on mortgages. Two sides of the same coin.
So here is your idea, and mind you I think this is brilliant… When someone wants to borrow from you, you make them sell you the land up front. The land goes into your name, you are the full legal owner, and you sign an agreement for them to buy the land back from you in the future. You transform the mortgage into an agreement of purchase and sale. You take advantage of that other side, the Yang, where the courts are brutal with their enforcement of agreements of purchase and sale. They show up on X date, at X time, at X place, with X amount of money and they get the land back. They miss this time, or the amount of money, by a minute or a dollar, and no deal the land is lost to them. This way the long history of enforcing sale agreements fanatically actually works in the lenders favor.
When this scheme went to court, you know what the court said? The court said famously “once a mortgage, always a mortgage” and said it would look through the legal twists and turns and get to the heart of the deal, that this was an attempt to borrow secured against land, which means you have to follow all the mortgage rules normally and it’s the intent of the scheme that matters.
This is a remarkable thing to do. Courts normally love the technical twists and turns. They virtually never simply throw their hands up and look through the technicalities of a transaction in private contracts and disputes. Except of course for the spoiled children of equity.
Courts so love legal technicalities that tax law, an area where it is literally money out of the hands of the judge’s employer, is an active and vital area of practice where the courts often allow tax schemes that are based on subtle legal technicalities to defeat the broader intent of tax legislation. If a court ever said “A tax, is a tax, is a tax” it would send shockwaves through the western legal order and call the impartiality of courts into question.
Now something I would like to point out in the interests of full disclosure. A moment ago I told you there was a qualification that was going to come with the explanation of the sceme to transfer the land and have the owner buy it back. And here it is: My property law textbook starts in the thirteenth century with this scheme of mortgage already in place – together with some other interesting scheme we will discuss later. But it is speculation on my part that there was a step before this. I don’t have a primary source on it. It seems like a fairly small assumption that the first step was a deal saying “if you don’t pay by X I get the land” and then step 2 was “ok give me the land up front and I’ll agree to sell it back to you for a set price on a date in the future”. Just logically those seem like steps that make sense. And the context of the judgments here seeing through these scemes implies there was this kind of earlier step. But I don’t have a primary source for it. So if you would like to be more formal in how you think about this, you can put down in your mind that the original mortgage involved buying the land back at a fixed date. And if you want my theory on it (which I think aids in understanding what is really happening and is probably true,) then start by thinking of a mortgage like a contract with a penalty provision for the surrender of a piece of land.
In my previous podcast on wills I gave some hypothetical will provisions that were attempts to imagine ways around old common law restrictions on what you could do with a Will. Now if you went to a lawyer worth his salt and asked for provisions like that, the lawyer’s mind should instantly turn to the phrase “a mortgage is a mortgage, is a mortgage” and advise you that while there might not be any legal precedent, and while this might be a completely different area of law, the courts hate to feel you have pulled one over on them, and they have, and will again in the future, simply throw up their hands and say you can’t bypass the rules. At least there is a risk of that.
For me this is why I fell in love with the law. A legal education, years of study reviewing thousands of cases, shows you that the law is a system of rules but also that those rules shift and respond to social pressures and those shifts even start to become predictable. It’s a game where the rules change but the more you play, the more you develop an intuitive sense for when you are in an area where there is a possibility, even a likelihood, for the rules to change under your feet.
So, our famous ruling that once a mortgage, always a mortgage. I think one of the things a legal education, and time in the practice of law, should teach you to respect is the concept of incentives and actions and reactions. You can’t have the court or legislature do something without there being a reaction from the market.
In this case I think that the reaction was truly positive. For the most part the effect of all this was to tame lenders to a degree. To make them understand that the business of mortgage lending needed to be about securing a loan as opposed to attempting to acquire property through default proceedings. The phrase the courts used a great deal in judgments was “crafty lenders”. However what the law also does is require lenders to be professional lenders in order to navigate the rules in such a manner as to make any money.
By way of a fore-instance. Today your standard mortgage is going to provide for fees for every late payment, every dishonored cheque. They also have figured out exactly how far in arrears you need to get before the court will award them their legal fees, exactly how much in fees they can incur, and if they are smart, they follow that to the letter.
So if you are unfortunate enough to fall behind on your mortgage you can quickly expect thousands of dollars of penalties and legal fees to be tacked on. You go to a big bank and they have this down to a formula. There is a specific pattern they follow to decide who to lend to, for how much, for how long, etc. etc. etc. and if you check every box you enter into a hyper efficient system for lending money.
If you don’t fall into this system, if you don’t check off every box, you fall into the secondary mortgage market. I have seen mortgage deals where the borrower had to pay tens of thousands of dollars for the privilege of borrowing simply because the lender was required to use a dash of intelligent thought to be willing to lend and the big banks were unwilling to do that (or the banks intelligent thought lead to a different result than a private lender’s intelligent thought). In any event, if you fall outside the major system you can expect getting a mortgage to be an expensive process simply because of how challenging it is for small players to navigate the system when they are not doing it a hundred thousand times each and every month.
Protect borrowers, harm borrowers. Ying, yang. Cause and effect. You have to wonder if the old English judges who came up with these rules would have made the decisions they did if they could see the results those choices have on our system today.
At the same time though, imagine how pleased with themselves judges of the past would be if they could know that today, the largest, most important, longest lasting, contracts that ordinary people signed had, built into them for no reason other than protecting british aristocrats from the jews, some of the most rigid protections you will find in any area of law. Actually I think a lot of those old judges would be appalled that the common man is making such use of these rules and the intention had been to help the aristocrats hold onto land they already owned, not countenance massive contractual non-adherence by people acquiring land in the first place because of the mortgage loan. But them’s the breaks in law. You make a law intending to help an angel and you are eventually going to be forced to let the devil take advantage of it.
Really this is one reason most lawyers are so hot under the collar for the precedent a case will set. Most people look at a case and see the specific outcome, but lawyers look at a case and see what it says for everyone else. A lot of the time the benefit (or harm) done in one specific case’s outcome is nothing compared to the benefit or harm that flows from the precedent it establishes. Once again, I do think these rules are fundamentally good ones and today they primarily help the little guys against the big banks. But if you think the judges of 1650’s England wanted to help the common man avoid the harsh consequences of a contract with stodgy, white haired, professional lenders who were only seeking to secure a reasonable return on their investment… well I have a bridge to sell you.
In the next podcast in this series I am going to talk about how mortgages are actually enforced. The difference between a power of sale and a foreclosure, and I am going to talk about how massively delicate mortgage systems are, and how two sentences in a law may have created one of the largest mortgage bubbles in Canadian history. So I hope you have enjoyed this installment, but, if you take nothing else away from this podcast, please remember that This is not legal advice.