The toughest legal issue in American real estate--the right of homeowners to pass along their low-rate, long-term loans to new buyers--received its first hearing before the United States Supreme Court earlier this week.
The court's decision in the case, which could come before this summer, will directly affect tens of thousands of consumers, including hundreds already embroiled in local legal battles with lenders over "creative financing" in at least two dozen states. It may well affect the market value of the home you live in, or help put your neighborhood savings and loan association out of business.
No matter which way the court rules, though, the national controversy over mortgage assumptions won't be stilled.
The real resolution, if one is to come this year, can only be made by Congress. There's at least a glimmer of hope on Capitol Hill that a constructive compromise affecting home-mortgage assumptions in all 50 states can be worked out, according to the staff director of the key Senate Banking Committee, Dan Wall. He readily concedes, though, that the heat of the coming election season--plus tactical decisions by interest groups to wait for the court's decision before negotiating anything --could kill the settlement.
Here's a quick overview of the case now before the court, and how at least some top legislative aides want to use the next two months to make everybody's home loan assumable.
The case the court is considering --Fidelity Federal Savings and Loan Association v. de la Cuesta--pits mortgage borrower against lender, state law against federal law.
A federally chartered S&L in California sought to block the assumption of one of its low-rate mortgage loans on the grounds that it contained a "due-on-sale" clause. That clause, which has been standard in most home mortgages since the early 1970s, allows a lender to demand immediate, full repayment of a loan (or to raise its interest rate) whenever the original borrower seeks to sell the property.
The due-on-sale clause prevents mortgage assumptions against a lender's wishes. It is considered vital by banks, credit unions, S&Ls and pension funds as a tool to protect themselves from loss in an era of rapidly rising interest rates.
State legislatures and courts in 17 states, however, have moved to limit lenders' abilities to enforce the clause. California courts, in particular, have held that state law bars automatic exercise of due-on-sale by mortgage lenders. The landmark Wellenkamp v. Bank of America decision in California four years ago prohibited lenders from blocking assumptions or raising rates on home loans unless they could demonstrate that the new owners of the property increased the lender's risk of default or loss.
The California Court of Appeals' decision in the Fidelity Federal case applied that ruling to federally chartered savings and loans. The case was appealed to the U.S. Supreme Court, and set for consideration this fall. After a request by the Justice Department, however, the high court agreed to expedite the case and hear it immediately.
Boiled down to its essence, the issue in Fidelity Federal is: Who runs federally chartered S&Ls? The federal government (which created them and regulates them)? Or state lawmakers (whose legal purviews traditionally extend to most aspects of real estate, finance and contracts within their borders)?
Federally chartered S&Ls have maintained for years that they cannot be bound by state laws that seek to regulate the terms on which they lend money. They insist that the federal law creating them--which dates back to the Depression--gives the Federal Home Loan Bank Board sole regulatory powers. And one of the regulations issued by the bank board permits automatic exercise of the due-on-sale clause to block low-rate assumptions.
Hence the controversy in California, and in a growing number of other states, including Georgia, Michigan, Ohio, Florida, Colorado and Utah.
For the nation's homeowners, buyers, real estate brokers and builders, the flap over states' rights carries big stakes. If Fidelity Federal (and the bank board) win the case --and the betting odds here this week tipped in that direction--it will undercut state limits on federally chartered lenders everywhere. (In Georgia, for example, state law limits rate hikes to one percent above the original rate--instead of the 6- to 8-point jumps lenders want.)
On the other hand, if Fidelity loses the case, it could produce a wave of state legislation across the country patterned after California's or Georgia's restrictions. Not only would that make hundreds of thousands of homes more readily salable in 1982 and 1983, it would also probably put large numbers of financially strapped S&Ls out of business, and raise new home-mortgage rates to unprecedented levels.
To avoid what he calls "an inevitable, horrible bloodbath" for one side or the other, Wall--working at the direction of chairman Jake Garn (R-Utah)--has been trying to come up with compromises. One that he advocates would allow assumptions to credit-worthy home buyers across the board--but with mandatory rate hikes (of 4 to 5 percentage points). The loans could convert into adjustable-rate vehicles at some point, to further meet the needs of lenders.
Another approach being explored by Wall and his staff involves lenders and borrowers "meeting each other half way" on rates. If a $50,000 loan at 8 percent were to be passed along to a new buyer under this compromise scenario, for example, the rate to the new purchaser might be bumped by 4 points to 12 percent. This would be half way between the initial rate and the going market rate of 16 percent.
Wall's staff has had discussions on these concepts on Capitol Hill with trade group representatives of lending institutions and the National Association of Realtors. Although no group has endorsed the idea of a federally legislated compromise on the assumption issue, representatives of lenders concede privately that it might be a way out of the economic and legal quagmire of "due on sale."
The Washington head of one lending institution trade group, for example, noted that the Fidelity Federal S&L case "won't even touch state-chartered S&Ls"--and about half the S&Ls in the U.S. are in that category.
"Maybe some type of diplomatic cease-fire agreement between Realtors on the one hand and lenders on the other could end this issue once and for all," he said. "I'm willing to negotiate."