The Federal Housing Finance Agency, Fannie Mae and Freddie Mac are taking steps to ensure that everyone has access to affordable housing — especially low- and moderate-income families. Certain components of these initiatives, however, inadvertently introduce a level of potentially ruinous financial risk to the very borrowers they are trying to help.
Specifically, the plan by the government- sponsored enterprises to let homebuyers choose between title policies and attorney opinion letters (AOLs) is, in certain circumstances, a recipe for injecting new hazards into the homebuying process. (Freddie Mac started accepting attorney opinion letters in lieu of title insurance, in limited situations, in May 2020, while Fannie Mae followed suit in April 2022.)
The reason to allow these letters to be used is well intentioned. Title policies can add more than $1,000 (and even a few thousand dollars) to the cost of a mortgage, which is significant for individuals with limited means. But the costs of inadequate title protection, in addition to errors in the conveyance, could be much greater, totaling hundreds of thousands of dollars while putting ownership in peril.
The fact of the matter is this: The level of protection from an attorney opinion letter does not meet the protection standards of a title policy. It also introduces new risks for lenders.
What are the differences in costs between title policies and attorney opinion letters? For a home in the $250,000 range, such as a condominium or townhouse being purchased by a first-time, lower-income buyer, the costs for owner’s and lender’s policies, along with all-inclusive settlement fees, is approximately $1,400 from a national title agent. Attorney opinion letters are priced about the same.
A common price from a national title company for a $250,000 refinance is about $850, which encompasses title search and settlement services, as well as a lender’s policy and closing protection. An AOL and settlement services from an attorney will often cost more.
Comparing outcomes to costs provides a more complete picture, however, and a recent analysis from the law firm Greenberg Traurig is particularly eye-opening. A side-by-side tabulation of the coverage provided by an American Land Title Association (ALTA) 2021 loan policy versus an attorney’s opinion with a liability wrap shows that the two are not equivalent options.
Impersonation, duress, fraud and forgery are covered by the ALTA loan policy but not by the attorney opinion letter, according to the analysis. Other risks that only these 2021 loan policies cover include the validity of the lien of the insured mortgage, the rights of backchain creditors, the risks uniquely associated with the sending of funds by warehouse lenders, defective judicial proceedings and the improper execution of documents.
Under undisclosed liens and encumbrances, an ALTA 2021 loan policy of title insurance also covers several areas that attorney opinion letters do not. These include tax, sewer and nuisance abatement liens at the federal, state or municipal levels, child and spousal support liens, and mechanics liens.
With such a disparity, why wouldn’t any potential homebuyer just choose the title policies? And why wouldn’t any lender insist on them in the first place? One commonly heard argument focuses on the low probability that a borrower will face a claim. But the whole point of insurance is to use the volume of the many to make protection affordable to those who wind up needing it.
Indeed, any insurance policy, according to the Insurance Information Institute, is intended “to reduce financial uncertainty and make accidental loss manageable. It does this [by] substituting payment of a small, known fee — an insurance premium — to a professional insurer in exchange for the assumption of the risk [of] a large loss, and a promise to pay in the event of such a loss.” In 2020, only 6% of homeowners who paid property and casualty insurance ended up submitting a claim.
Title insurance claims typically hover below 5% of all policies — but not always. For example, from 2008 to 2011, in the wake of the Great Recession, the rate was about 10% to 11%. Given the industry’s movement into a more challenging economic period, it’s prudent to exert extra care right now.
Picture a couple with a new baby, two years after they have closed on their home, faced with an unexpected claim. They would be hard-pressed to pay thousands of dollars in legal costs if their attorney opinion letter doesn’t cover a problem with their title or its conveyance.
Mortgage lenders, too, face the possibility of being left high and dry by attorney opinion letters. A borrower could even file a claim against a lender for advising them to take the AOL route. Taken to another level, a zealous attorney could file class-action lawsuits against lenders that routinely follow this path.
Another, more practical challenge is that when borrowers opt out of title policies, mortgage bankers also lose closing protection. This increases a lender’s risk exposure since most title problems are discovered during the closing and post-closing stages.
Loan buybacks are another potential risk, should originators sell loans without title insurance to servicers. Fannie and Freddie have not laid out clear policies on what would happen if there were title issues in these instances.
In addition, if banks were to sell loans without title policies years after first acquiring them, investors might not want them. This is currently causing much discussion in the mortgage banking community.
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Mortgage industry innovation is always a positive, especially if it’s aimed at helping more borrowers build wealth through homeownership. Title policies protect those who are vulnerable and help to guard their investments as long as they own their homes.
They also help protect the integrity of lender and investor assets, enabling them to transact with confidence. Not sharing full information on the value of these protections is a disservice to both consumers and the mortgage industry as a whole. ●