Title Trauma: What You Should Know About Foreclosures and Short Sales

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Who owns this house?

It’s not as easy to answer that question as it used to be. Foreclosures, short sales, bankruptcies and other financial traumas have injected drama into the typically staid world of title insurance. Here’s what some of the most common complications mean for you, the potential buyer.

The title to a house is the document that proves that the owner owns it.  Without that proof, the house can’t be sold or bought.

Title insurance is written by title insurance companies. The title insurer researches the history of the house to see if there are any complications in its ownership. If the title appears to be clean, the insurer writes a policy promising to cover the expenses of correcting any title problems discovered after the sale. The title insurance policy might cover you, the buyer, or the lender who gives you your mortgage, or both of you.

Until recently, title insurance was a sleepy world. Complications rarely arose, and when they did, they were typically small-scale, such as neighbors arguing over the placement of a fence and the ownership of few inches of land on either side of it.

That changed in the wake of the housing bust that started in 2007. While still not sexy, title insurance has gained sudden relevance. Buyers and lenders are worried that they will buy title problems along with the house. Buckle in for a guided tour of the road to a clear title and the potholes to avoid along the way.

Why Everyone Cares About Your Title

When you buy a house with a loan, the lender has the right to claim the house if you stop paying.

Under normal circumstances, the homeowner pays off the mortgage and the lender releases the title (the legalities of this vary by state). That might happen when the homeowner sells the house and repays the mortgage with the proceeds of the sale. Or, it could happen if the homeowner stays in the house for the duration of the mortgage and eventually makes that final mortgage payment.
Meanwhile, the owner might take out other loans also collateralized by the same house. A second mortgage, a home equity line of credit, construction loans for remodeling: the lenders behind those loans also have claims on the house. As well, contractors often put liens on houses when homeowners don’t pay house-related bills.

All of these claims against the house “cloud the title,” making it impossible to sell the house until the claims are settled. If you don’t repay these loans, any of these lenders will put a lien on your house. When you do eventually sell it, you must repay that loan (and probably some penalties) with the proceeds of the sale. Only when the creditors are satisfied is the title cleared and the property truly available for purchase.

In the wake of the bust of the 2002 – 2007 real estate bubble, house prices started to decline. Owners with little equity soon found themselves owing more on their home loans than their houses were worth. This state of affairs is known as being “under water” on the loans. And that has touched off a long wave of title problems, complicating the process of buying the affected houses.

Types of Title Complications

Mosty homeowners continue paying back their loans even if the value of the house has eroded. But some decide that they will not continue paying for a house that is worth less than they owe on it. Separately, others must move for job, family or other reasons, and face house sales complicated by their loan situations. No matter why the house is being sold, its title problems must be cleaned up so they are not inherited by the buyer.

Short sale – A home being sold for less than the mortgage, with the lender agreeing to take the lesser amount to settle the loan. For example, a homeowner might have bought the house for $200,000, putting down 5% and carrying a mortgage of $190,000. If the market value of the house declines to $175,000, that homeowner has lost her down payment. On top of that, her $190,000 mortgage is now $15,000 more than the house is worth. She is underwater on the mortgage.

If the homeowner were to sell, she would have to bring $15,000 to the closing to make up the difference to the lender. But what if the lender is willing to share the losses with her? The homeowner might be able to persuade the lender to accept $175,000 at closing. She loses her $10,000 down payment and the lender writes off $15,000 of the loan. Doing so clears the title and makes the house available for a clean sale. That’s a short sale.

Short sales are easy to understand on paper but hard to accomplish in real life. It’s hard to get the ok from the lender to take a loss on the mortgage. The paperwork can drag on for months. Other liens – such as unpaid bills from contractors who helped get the house ready to sell — often pop up, further entangling the process.

What you must know:

  • The process will be slow and unsteady, with many frustrating delays.
  • The title search might uncover nasty surprises, such as unpaid taxes
  • Few realty agents are adept at navigating the process
  • You might have to pay a real estate lawyer to review documents several times

Foreclosure -If a homeowner just can’t afford the house, he may decide to relinquish ownership and give the house to the bank that holds the mortgage.  This is called a Deed in Lieu of Foreclosure. Or, the foreclosure decision might be made for the homeowner when the bank  initiates foreclosure proceedings.

Foreclosure is a lengthy and complex process. The lender must prove that it has accurate, complete paperwork supporting its right to claim the title. Homeowners often try to win loan modifications or other types of help to salvage the situation and stay in their homes. Related financial and legal problems, such as bankruptcy, multiply the complications – and the number of lawyers involved.

Houses in foreclosure look like bargains: typically they sell for 35% less than what they would have fetched if they were not in foreclosure. But financially distressed owners often let their properties fall into disrepair. Foreclosures can come with many hidden problems, from leaky basements to bills from homeowners’ associations to quarreling lenders. It takes a long time to sort out who is owed what, how they will be paid, and when the title will finally be cleared.

What you must know:

  • The title search might uncover nasty surprises, such as unpaid taxes
  • You might want to order up a title search when you make your first offer so you don’t get surprised at the point of closing
  • Disputed title and loan paperwork might sink the deal
  • You might have to pay a real estate lawyer to review documents several times
  • Closing fees may be high due to the complicated paperwork
  • The closing will probably be difficult to schedule, with multiple delays

Bank Owned or REO – Real Estate Owned – Once a house is taken over by the lender that holds the mortgage, it is managed by that lender. Lenders are trying to figure out what to do with the millions of repossessed houses they now own. At the end of 2010, lenders were hesitating to put too many houses back on the real estate market for fear that they would trigger another slide in house prices. But, analysts agree that lenders will have to start selling the houses at some point, though there is no clear standard for the condition of those houses or exactly how the banks will introduce them to the market.

What you must know

  • Some lenders are working with nonprofits groups to sell groups of houses for neighborhood redevelopment. If you qualify for one of those programs, you might get a refreshed house at a good price.
  • Just because the lender owns the property does not mean that the lender’s staff will have tidy records and be responsive when a sale is in process
  • Title problems might still be unresolved
  • The lender might offer special financing or related programs to purchasers of houses in its portfolio
  • Lenders typically present REO houses “as is:” that is, any repairs are at the expense of the buyer. But some lenders are open to a bit of negotiating. Expect to make no more than one counteroffer requesting an allowance for identified repairs and closing cost concessions