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Friday, December 23, 2011

What Makes a Mortgage Bad, Part 2

There are many ways a mortgage can be "bad," meaning that either its required payments are unlikely to be made or the collateral securing it can be damaged and lose value. Rarely is the structure of a mortgage, by itself, the problem; rather, the underwriting decision -- whether or not to give a particular borrower the loan -- is almost always the source of later troubles.

(See Part 1 of this series here.)

These decisions are made by the banks, with input (and incentives in the form of order flow) from mortgage brokers. In many cases, the decisions were egregious and show (both at the time and in retrospect) either a disregard for risk or incompetence in identifying it. In short, issuing banks originating mortgages committed an epic fail in their due diligence.

Surely there were irresponsible -- and unscrupulous -- borrowers who were gaming the system. (Many of these borrowers were professional investors and speculators.) Other irresponsible people elected to stop paying mortgages. The notion of strategic defaults and the game of "catch me if you can" has led to people living rent-free for upwards of two and even three years in judicial foreclosure states like New York (986 days on average to close a foreclosure) and New Jersey (984 days). 

In many cases, the same banks that were derelict in their due diligence of loans are now equally derelict in pursuing foreclosures. Even worse, there are indications that banks are selectively prosecuting for foreclosure those considered least likely to fight and the ones considered the easiest to evict.

And the rationale? Their homes would presumably be the easiest to flip upon seizure, and the purchasers can be funded with a mortgage from...you guessed it...the bank. 

But getting back to the core issue of what makes a bad mortgage. It almost always is a bad underwriting decision. 

A keen observer -- such as a lawyer like me who knows what's in the documents and what anomalies to look for -- can spot the flaws and risks in a mortgage applicant's file which make consistent payment a risky proposition. 

Responsible due diligence is the key to success. An equally diligent investigation can uncover the mistakes of the past. 

Eric Dixon is a New York lawyer.

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