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Foreclosure Documentation Crisis Could Cloud Title for Homebuyers
Thousands of homeowners and investors who purchased foreclosed properties during the current downturn could find their ownership in question owing to growing concerns over improprieties in how those foreclosures were handled.
Bank of America today became the third major mortgage servicer to announce this week that it is suspending foreclosures in 23 states to investigate reports that faulty documentation was routinely used in repossessing properties. Ally Financial, parent company of GMAC Mortgage, and JP Morgan Chase made similar announcements.
Impacts could be widespread
With distressed properties currently making up from one-quarter to one-third of existing home sales, depending on which survey is used, the potential for problems with tainted titles is huge. Even if the vast majority of documentation flaws turn out to be inconsequential, a small percentage of serious flaws could throw into question the ownership of tens of thousands of homes.
It could also put the damper on current foreclosure sales, as few buyers would be willing to buy a foreclosed home with a tainted title, and even fewer title companies and mortgage lenders would sign off on such a purchase.
The situation is believed to affect virtually all major mortgage servicers. The 23 states involved require that foreclosures go through the court. This means that a lender seeking to repossess a property must file an affidavit asserting not only that the loan is in default, but also affirming ownership of the loan and establishing the right to foreclose.
Faced with a flood of foreclosures, bank employees have reportedly engaged in "robo-signing," routinely signing off on tens of thousands of foreclosure affidavits without personally verifying the information contained. One Ally Financial employee testified last May that she and seven fellow employees would sign off on as many as 18,000 affidavits a month.
A problem with "toxic titles"
The problem goes beyond mere legal technicalities. With the way modern mortgages are repackaged and resold to investors as mortgage securities, often involving multiple transactions, the chain of ownership can get muddled. And if the paperwork is lost, the foreclosure can be challenged by an attorney demanding that a lender prove ownership of the loan.
"Wall Street was very good at packaging loans and making sure the money flowed to the right people, but not so good at keeping track of mortgage documents," Kathleen Engel, a financial law professor at Boston's Suffolk University, told Bloomberg News. The result, she said, is "a growing number of toxic titles."
At the direction of their regulator, the Federal Housing Finance Agency (FHFA), both Fannie Mae and Freddie Mac today directed their mortgage servicers to begin a review of foreclosures involving mortgages held or insured by the two agencies, and to take steps to ensure all legal requirements are met.
Fannie, Freddie taking action
In a letter to the CEOs of Fannie Mae and Freddie Mac, FHFA Acting Director Edward Demarco asked that the two agencies "develop solutions that are tailored to address the specific problems identified and protect the rights of borrowers, while also minimizing taxpayer losses," suggesting the agency believes at least some foreclosures will be compromised by faulty documentation.
Homeowners and investors who purchased foreclosed properties should be protected by their title insurance in the event their title proves tainted by a faulty foreclosure. The title companies in turn would be able to recover their losses from lenders who sold the properties without proper title and who would end up taking the loss.
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