Foreclosure Risks: Title Defects

One risk of buying an REO (bank-owned) property that you rarely hear about is the potential for title issues. Buyers incorrectly assume that since liens are typically extinguished in a foreclosure, that the title is free-and-clear. Not always so!

Let’s discuss the process. Lenders require buyers to obtain title insurance on the property. These policies protect the lender, and if you opt for extended coverage, the buyer. (See my post on how to save money on a title policy on a non-REO purchase here.) The policy protects against defects in the title, competing claims, etc. To issue this insurance policy, the settlement attorney’s office will perform a title search, issue a commitment to insure (sometimes called a binder).

The REO addendum (see post on risks of that addendum here) is usually written such that the bank is protected even if the title they convey isn’t perfect, so you can’t come after them if you determine later that there is a title issue. More importantly, the addendum requires only that they convey insurable title, not marketable title, as is required in the standard Regional Contract. Remember that the addendum trumps the contract, so don’t go relying on that paragraph in the offer that requires marketable title.

What’s the difference between insurable and marketable titles? Marketable means it’s free from threat of litigation. Insurable does not guarantee clean title, but rather simply requires that there is a title insurance company willing to “insure over” the defect. (Ever wonder why bank addenda require that you use their title insurer and settlement agent?)

Why should you care about insurable versus marketable title? Because when YOU go to sell down the road, you won’t have the benefit of that trump card, the REO addenda, nor will you have a settlement attorney in your pocket that will “insure over” defects. It’s possible that the price on an REO deal will be such that you don’t care about the insurable versus marketable difference—but make sure you review, and ask lots of questions about, what is being “insured over,” or you may find yourself paying to cure title defects years later when you sell.

What can a buyer do to protect himself? First, choose your own settlement attorney. Have them perform a title search as quickly as possible to identify any problems early. If the bank insists on using their title company, consider shelling out the few hundred for your own concurrent title search. Many foreclosures have significant title issues, and many bank addendums provide a very tight timeframe for identifying and objecting to them. An example of an issue that might be identified would be if the listing included a parking space, but upon searching the deeds, the bank didn’t actually own the parking spot—how can they convey what isn’t theirs? Second, review that title search and make sure you understand all the possible defects. Finally, buy the best title insurance you can–it’s a one time cost at closing that may save you many times more than the cost of the policy.

Read more: Beginning of series on Foreclosure Risks

Resource: A great local settlement attorney – Ekko Title

If you’re interested in learning more about REO and foreclosures, or thinking of buying one, I’d love to advise you on the home buying process.

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FAQ: Buyer’s Closing Costs

Many buyers are aware that they have fees related to the purchase of a new home—a rough guide is 2.5%-3% of the transaction value–but what are these fees, and are there ways to minimize them?

First, a few clarifications. Both buyers and sellers have closing costs in a transaction; the sellers’ are typically much higher (because they pay both real estate brokers) than the buyers’. These fees are typically paid at closing—they come out of the sellers’ proceeds, and the buyer can either pay cash, or can negotiate to have their portion of the closing costs paid by the seller (read more here.)

For this post, I’ll focus on the buyer’s fees. A lender should provide you with a Good Faith Estimate (GFE) when you apply for a loan. This GFE is essentially an estimate of your “HUD-1” form, which you will receive at closing. Each lender has their own preferred format, but you should be able to compare apples-to-apples by looking at the section headers, or, even better, the line item numbers. It’s important to note, though, that lenders only control certain sections, while others may be simply based on their own experience. When comparing lenders, it’s important to focus only on the line items that the lender actually controls.

The fees vary by jurisdiction, broker, and settlement attorney, but a good way to categorize them would be:

  • Prepaids – These are generally required by the lender, and may include prepaid insurance, prepaid property taxes, and prepaid interest. Another common prepaid item is condo/HOA fees. These vary based on the day of the month that you close, since they are pro-rated between buyer and seller.
  • Points – A point represents 1% of the loan balance and are charged by lenders. This, along with the fees, can easily amount to thousands and thousands of dollars, so it’s important to discuss this with your agent and your lender.
  • Fees – These are fees charged by real estate brokers, settlement attorneys, and lenders, and are the toughest to judge for “reasonableness” without experience. These vary widely, particularly among lenders. Some real estate agents will pay their broker’s fee on your behalf—be sure to ask them. For lenders, whose fees can be substantial, it’s important to know early in the process what they’ll charge. These fees can generally be found on your Good Faith Estimate in the 800 section, but look in the 1300 “Additional” section too. Broker’s and attorney’s fees are scattered throughout the closing statement sections.
  • Title Insurance – This is paid by the buyer and, depending on the policy, can amount to thousands of dollars. It’s a one time charge that covers you in the event of a problem with the chain of ownership. See my post on how to save some money with title insurance here. This is in the 1100 section.
  • Government and Transfer Charges – Paid to the local jurisdiction. These can be quite substantial—for example, in the District of Columbia, the transfer (paid by the seller) and recording taxes (paid by the buyer) are 1.1% each. Northern Virginia sellers just had big increase (from $1 per $1000 in value to $5 per $1000) in their transfer taxes.

Read more about how to spot “junk fees” in my post here. This is just a high level summary of some of the most common items on a HUD-1, so be sure to ask your agent to walk you through the expenses and strategize with you on how to keep them to a minimum!

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Common Buyer Mistakes: Title Insurance

I often get asked for the most common mistakes buyers make, and there are many. One that is less well known is around Title Insurance. Title insurance is required if you have any mortgage on the property. There are actually 3 types, all of which are paid by the buyer. The lender’s coverage (required), the owner’s coverage (optional) and owner’s “enhanced” coverage (optional.) Title insurance runs into the thousands of dollars and is often the majority of a buyer’s closing costs at settlement. So what is Title Insurance and is there any way to save money on it?

Title Insurance is protection against claims against the property. You pay the premium one time, at settlement only, and it covers you for the length of time you own the property. Title insurance and the title search is coordinated by your settlment company. A title insurer does a title search–a review of Court House records to determine if there are any frauds, forgeries, or errors in the chain of title to the property you are about to purchase. It’s common for documents to be misfiled or have errors, and your lender knows this. Therefore, they require you to purchase a lender’s policy of title insurance to protect their interest in the loan. The lender’s policy does not protect you. As you pay down your loan, there is no longer coverage unless you purchase the optional “owner’s policy.” It covers you in case someoen else turns out to own an interest in your title, there is fraud, forgery or duress, or defects int eh recording. While these events don’t happen often, the cost of the optional owners policy is fairly minimal (about $1 per thousand of loan amount). You can also buy “enhanced” owner’s (about 20% more than the standard policy) coverage that adds in things like being forced to remove a structure that encroaches on a neighbor’s land, building permit violations, post policy forgeries and clouds on the title, violations of building setbacks, and insurance coverage even after the loan is paid off.

Some people argue title insurance is not necessary in most cases, and they’re right. Things like homeowner’s insurance aren’t necessary most of the time, either, but people sure are glad when something goes wrong and they have that policy! Isn’t that what insurance is…protection in csae you ever need it? For me the key is not whether to buy it (besides, the most expensive portion of it–the lender coverage– you have no choice about anyway), the key is how to minimize the cost. And no, the answer isn’t to shop around.

The key way to save money on title insurance is two words most buyers (and many agents!) don’t know: Reissue Rate. A reissue rate–which you have to request–is a discount on the policy premium that is offered when a property has had another full title search in the last ten years. In this area, that’s almost always the case. So say you’re buying a condo from someone that has lived there 3 years. If you can get their title insurance policy number, then your title insurance company can partially rely on that search, and they only have to search the last 3 years, saving them time, and saving you money. How much money? Into the thousands of dollars depending on how much the property is worth (fees are charged as a percentage of the property value.) For most first-time buyers in this area, you can save about $500-800 dollars.

Make sure to ask your agent if they know what a reissue rate is and how to get one.

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