The law finally caught up with the home foreclosure mills. Some of the leading lenders and mortgage servicers -- including Bank of America, JPMorgan Chase, and GMAC Home Mortgage, a unit of Ally Financial -- have conceded that they've mistakenly filed for foreclosure based on faulty or even forged affidavits. At some mortgage service firms, an employee might robo-sign as many as 6,000 legal documents a week, making it impossible to verify the facts.
Foreclosure Mess: What it Means for You
All of these borrowers are in default and most will almost certainly lose their homes. Some, however, might have been able to recover if the lender had offered to modify their loan. Their gripe, a fair one, is that lenders have been fatally unresponsive and in too big a hurry to evict. My MoneyWatch colleague, Ilyce Glink, says they're in "loan mod hell."
Various types of moratoriums are now in place in the 23 states that put foreclosures through the courts. Foreclosures in the other states are less affected, because borrowers can't bring a challenge to a judge. Even so, title insurers are taking more time to examine documents, which can drag the process out.
What does this mean to people buying and selling homes? Plenty.
It will take even longer for the real estate market to recover. The record inventory of homes in foreclosure hangs over the housing market like a sword, says Guy Cecala, CEO and publisher of Inside Mortgage Finance Publications. Until it's cleared, sales and prices won't return to a healthy track. The paperwork errors might delay foreclosures for just two or three additional months, if the lenders merely have to clean up their act, Cecala says. But if massive legal challenges develop, the housing depression could drag on for several years more.
Owners who haven't been paying their mortgage might have many more months to stay in their homes before they're forced out. Already, it's taking an average of 478 days before foreclosure begins, according to LPL Applied Analytics, because the system is so clogged. People who fight eviction might last even longer. They're unlikely to recover their homes, however, even if a court agrees that the documentation was bad. Once borrowers get more than six months behind on payments, they rarely catch up, Cecala says. As a practical matter, they use those extra, non-paying months to put their finances back in order. (Foreclosures usually move faster in states where they don't go through the courts.)
Owners who think that fighting foreclosure will bring lenders to the bargaining table are probably mistaken. They're hoping for a cut in the interest rate and in the amount of the loan. But two-thirds of the loans outstanding are bundled into mortgage securities and they're governed by contract, Cecala says. Investors rarely agree to take less than they're owed. The servicers will merely correct their paperwork and file for foreclosure again. In egregious cases, courts might order the lenders to pay the borrower's court costs.
Buyers should always take title insurance. A title search will pick up errors before you sign the check and protect you if something was overlooked. In the unlikely event that a former owner returns to challenge the foreclosure, the insurance company will defend you. If there's a problem, the insurer will fix it or cover your loss, says Michael Waiwood, CEO of EnTitle Insurance. All of this is highly hypothetical. People who lose their homes usually move on. They couldn't afford their mortgage before, and almost certainly won't be able to catch up on that old loan.
If you're in the process of buying a foreclosed home, the transaction might take longer than you'd hoped. Title insurers are looking more carefully at the properties they accept. Old Republic National Title, for example, reportedly told its agents that, for now, it won't write policies on homes foreclosed by GMAC and JPMorgan Chase. Old Republic declined comment. Other insurers are still covering these properties, but with caution. The industry hasn't reached a consensus on how to proceed, Waiwood says.
If you're buying a pre-foreclosure, get title insurance before you sign. These homes have been scheduled for foreclosure but the owners are still living there. If they have some equity in the property, they'll be eager to sell at a bargain price that nets them at least some money beyond what they owe the bank. If they're underwater, they're looking for a short sale, where the bank agrees to accept less than it's owed. As long as you get title insurance, your purchase is safe.
If you're buying at a foreclosure auction, you run more than the usual risk. This is the land where specialists roam. Search the title yourself, says John Reed, Author of How to Increase the Value of Real Estate. Do it on the afternoon before the sale, to catch as many last-minute liens as possible. You can't get title insurance until after you buy the property, so you're running the risk that an insurer might have doubts.
Sloppy documentation isn't just an artifact of the recent real estate frenzy. When I bought an apartment in 2004, my lawyer discovered an error in the chain of title. I went through with the transaction but put a substantial part of the purchase price into escrow, not to be released until the problem was fixed. That gave the person who sold the apartment a major incentive to clean up the paperwork, which he did in about six months.
For investors, a bad title could be a buying opportunity. The documentation problem is invariably solved, Reed says. You might be able to pick up the property at a bargain price, rent it out, and realize a profit when the title is eventually cured. In real estate, there's no mistake that doesn't do somebody good.
More on MoneyWatch:
Will Foreclosure Freezes Fix the Housing Market?
Thinking About a Mortgage Default? Beware the Taxes Due
Mortgages After Financial Reform: 5 Ways They'll Change
What Happens When You Walk Away from a Mortgage Loan?