Safely Closing REO Properties

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1 Safely Closing REO Properties REO means real estate owned. Sometimes called ORE. An REO sale is one in which the property has been foreclosed on and is now being resold to a new buyer. Typically, the lender who foreclosed is the seller. Less frequently, the seller is an investor who purchased the property at the foreclosure sale. If the loan was an FHA or VA loan, the lender deeds the property to FHA or VA, who then sells the property. If the loan was backed by Fannie Mae or Freddie Mac, the lender typically deeds to one of those entities, who then sells the property. This webinar will discuss ten topics to understand and address when handling a sale of REO property. 1. Understand the Foreclosure Process A. Judicial Foreclosures In some states, foreclosures are conducted through the court system. These states include FL, ME, MD, NJ, NY, and PA. B. Non-Judicial Foreclosures Other states allow many foreclosures to be conducted privately, outside the court system. These states include AZ, CA, GA, MA, TX, and WA. C. Other Systems Colorado uses a public trustee. Federal Single Family Mortgage Foreclosure Act and Federal Multi-Family Mortgage Foreclosure act both permit, but not require, HUD to foreclose under different rules. D. Deed in Lieu of Foreclosure Most states permit the borrower to voluntarily deed the property to the lender, which avoids the lender having to go through the foreclosure process. However, a deed in lieu can create other title issues. - Junior liens are not eliminated. - The conveyance may be set aside in a subsequent bankruptcy. 2. Who is the Proposed Insured? Never issue a policy to the person who is buying the property at the foreclosure sale. A buyer at a foreclosure sale is not a bona fide purchase for value, and thus takes title subject to unrecorded interests.

2 The foreclosing lienholder does not need a policy, because its loan policy still provides coverage. 2. CONTINUATION OF INSURANCE The coverage of this policy shall continue in force as of Date of Policy in favor of an Insured after acquisition of the Title by an Insured or after conveyance by an Insured, but only so long as the Insured retains an estate or interest in the Land, or holds an obligation secured by a purchase money Mortgage given by a purchaser from the Insured, or only so long as the Insured shall have liability by reason of warranties in any transfer or conveyance of the Title. It is permissible to issue a policy to the Secretary of Housing and Urban Development following a deed to HUD from the lienholder that has foreclosed an FHA loan. 3. Verify That the Foreclosure Was Properly Completed A. Judicial Foreclosures 1) The mortgage being foreclosed must create a valid and enforceable lien on the property. - Was the mortgage properly executed and acknowledged by all of the record owners of the property? - Does the mortgage contain a proper legal description? - Was the lien created in a title insured transaction? 2) The party foreclosing must be the lienholder of record. - Is there a recorded assignment? - Are there any gaps in the chain of assignments? - Was the foreclosure started after the last assignment? 3) Proper foreclosure procedures: - Were all necessary parties named in the suit? - Were all named parties properly served with process? - Is the party foreclosing the lienholder of record? - Was the foreclosure started after the last assignment? - Has the time to file any appeal passed? B. Non-Judicial Foreclosures 1) The mortgage being foreclosed must create a valid and enforceable lien on the property. - Was the deed of trust properly executed and acknowledged by all record owners of the property? - Do the deed of trust and vesting deed contain a proper legal description? - Was the deed of trust created in an insured transaction? 2) Assignments are a common pitfall. The Appointment of Substitute Trustee must be signed by whoever the lienholder or mortgage servicer is on the date it is signed. - Beware of backdated appointments. - Beware of backdated assignments. (For example, Executed to be effective January 1, 2011, but the notarization shows a later date) A foreclosure sale that is not conducted by a properly appointed substitute trustee is void. 3) Substitute trustee s deed This conveys the property to the purchaser at the foreclosure sale. It must contain all of the required elements of any other deed (e.g., legal description, properly names grantee, acknowledgement). It also contains recitals describing the deed of trust that was foreclosed and the foreclosure process.

3 4) The substitute trustee should sign and record an affidavit stating that he or she complied with each step required in the foreclosure process. The affidavit is prima facia evidence of the facts stated therein, so the affidavit should describe these steps, not just say I did it in accordance with all legal requirements. 5) Ibanez and LaRace Cases In January 2011, the Massachusetts Supreme Court voided two foreclosures because the banks did not have the proper paperwork proving they owned the loans. The decision held that the common practice of endorsements in blank, used in securitized loans, did not properly document ownership of the loans. One justice referred to the utter carelessness of the banks in documenting their rights. The decisions opened the door to the invalidation of other Massachusetts foreclosures. The court s reasoning may encourage consumer lawyers to attempt to invalidate foreclosures in other states. C. Deed in Lieu of Foreclosure A deed in lieu of foreclosure must contain all of the required elements of any other deed (e.g., legal description, properly named grantee, acknowledgement). A deed in lieu is often not signed at a title company or an attorney s office. Always verify the authenticity of the signature. A deed in lieu typically contains nom-merger language, stating that the lien on the property is not extinguished by the acceptance of the deed. This allows the lienholder to foreclose out junior liens. Because of this language, it is necessary to obtain a release of the lien from the lender in connection with the sale of the property by the lender. Different types of foreclosures often require different procedures (homestead, commercial, home equity, reverse mortgage, condominiums, HOAs, tax liens, involuntary liens). Read and comply with all of the requirements in your commitment! 4. Status of Borrower Was the borrower alive at the time of the foreclosure? If there is a probate estate open on the borrower, the probate court may have exclusive jurisdiction over the borrower s assets. A non-judicial foreclosure is subject to challenge and may be overturned. A judicial foreclosure or deeds from the beneficiaries of the estate typically will be required. Has a guardian been appointed for the borrower? Has a receiver been appointed for the borrower? If so, any foreclosure sale must be court approved. The Federal Servicemembers Civil Relief Act prohibits foreclosing on a borrower who is on active duty in the military or who has been on active duty within the last three months, provided the debt was incurred prior to enlistment or being called to active duty. Obtain proof that the borrower was not in the military at the time of the foreclosure, or three months prior thereto. Bankruptcy All bankruptcy records nationwide are available online through the PACER (Public Access to Court Electronic Records) system. See PACER Case Locator The PACER Case Locator is a national index for U.S. District, Bankruptcy, and Appellate courts. A small subset of information from each case is transferred to the PACER Case Locator each night. The system serves as a locator index for PACER. You may conduct nationwide searches to determine whether or not a party is involved in federal litigation.

4 5. Property Must Be Vacant This usually is not a problem when an institution such as Fannie Mae is selling the property, because they typically do not put the property on the market until the borrowers have vacated and the property has been secured. An affidavit from the listing agent that the property is vacant usually is sufficient. However, this often is a problem when a homeowners association (HOA) has foreclosed for unpaid maintenance assessments. Always check with underwriting if you are being asked to insure a sale from a homeowners association or an investor who purchased at an HOA foreclosure sale. Occupancy can also be an issue when dealing with property sold by private investors who have foreclosed fraudulent foreclosure rescue schemes, squatters in certain neighborhoods. An exception to the policy for Rights of Parties in Possession is not sufficient. Federal Protecting Tenants at Foreclosure Act Bona fide third party tenants must receive a 90-day notice before being evicted as the result of a foreclosure of a federally-related mortgage. With some exceptions, the law requires that in the event of foreclosure, existing leases for renters are honored to the end of the term of their lease. The state exceptions are for tenants without a lease, tenants with a lease terminable at will under state law, or where the owner acquiring the property will occupy it as a primary residence. In these cases, the tenants must receive a minimum of 90 days notice to vacate. This law does not affect the requirements of any state or local law that provides longer time periods or other additional protections for tenants. Commercial Properties The vacancy requirement does not apply to commercial properties typically occupied by tenants, such as office buildings, shopping centers, and apartment complexes. 6. Rights of Redemption A. Federal Liens If a federal tax lien was eliminated by a foreclosure sale, the IRS has a period of 120 days to redeem the property. If a federal abstract of judgment lien was eliminated by a foreclosure sale, the Justice Department has a period of one year to redeem the property. B. Borrowers Rights of Redemption Many states give the borrower the right to redeem the property for a period of time following the foreclosure sale. The borrower pays the lender the back payments, plus an additional sum set by law, and reacquires title to the property.

5 C. Some states provide for rights of redemption following specific types of foreclosure. For example, in Texas: - Ad valorem taxes (non-homestead) 180 days - Ad valorem taxes (homestead) 2 years - Condominium maintenance 90 days - Homeowners association dues (owner) 180 days - Homeowners association dues (lienholder) 180 (but not before 90) days - Purchase money no redemption rights With very limited exceptions, we will never insure the sale of property if there is an unexpired right of redemption. 7. Lawsuits A. Wrongful Foreclosure Actions The foreclosed borrower may sue the lender, alleging wrongful foreclosure. Never close an REO sale if there is a lawsuit pending alleging that the foreclosure was invalid for some reason, regardless of what your or the seller may think about the merits of the lawsuit. B. Deficiency Actions The lender may sue the borrower for a deficiency judgment (the amount still owed on the loan following the foreclosure of the property). A deficiency lawsuit will often lead to a counterclaim by the borrower against the lender for wrongful foreclosure. Always contact underwriting before insuring if the lender has filed a deficiency lawsuit against the borrower, regardless of whether or not the borrower has filed a counterclaim. C. State Regulatory Actions In response to the allegations that some lender systematically engaged in wrongful foreclosure practices, such as robosigning, some states (e.g., Ohio) have filed lawsuits to halt foreclosures by certain lenders and law firms. Always contact underwriting if you are aware of such an action in your state. 8. Other Lienholders A. Junior lienholders Many states require that notice of the foreclosure sale be given to any junior lienholders of record. Some states require notice to junior lienholders only in certain types of foreclosures (e.g., ad valorem taxes). If notice is required but not given, the junior lien is not eliminated by the foreclosure. B. Senior Lienholders The purchase at a foreclosure sale takes title subject to any liens that have priority over the mortgage that was foreclosed. Beware: Tax Lien Deeds of Trust. A homeowner may borrow to pay ad valorem taxes and give the lender a deed of trust on the property. This deed of trust will be superior to the purchase money lien, even though it is recorded later.

6 C. Mechanic s Liens In most states, the priority of a mechanic s lien dates from the date that the work was done, not the date the lien was recorded. When dealing with new homes, a mechanic s lien often will be superior to a purchase money lien recorded earlier. Even if the mechanic s lien was inferior to the deed of trust that was foreclosed, the mechanic s lien claimant may still have the right to repossess certain removable items. If there are mechanic s liens of record that are not being paid, always get an underwriterapproved indemnity from the lender/seller. D. Homeowners Association Liens An HOA maintenance lien may or may not have been eliminated by the foreclosure. It depends upon the language in the restrictions, as well as the nature of the lien that was foreclosed. For example, most (but not all) HOA liens are subordinate to purchase money loans. Most (but not all) HOA liens are superior to home equity loans. The HOA will typically have a superior lien as to assessments that accrue after the foreclosure sale. Any disputes between the lender/seller and the HOA regarding the amount owed must be resolved prior to closing! TRIVIA QUESTION Which of these famous properties has not been foreclosed upon and subsequently resold by the lender? - John Hancock Tower - Neverland - Trump Tower Penthouse - Empire State Building - Greek Isle Casino 9. Value of Property Properties that have been foreclosed on often were not well maintained by the borrower prior to the foreclosure. Thus, the sales price may be less than the tax value or the value of otherwise comparable properties. That said, beware of the following situations. - Sales price is extraordinarily less than the tax value of the property. - Sales price is higher than the balance owed on the loan that was foreclosed. - The lender/seller was related to or affiliated with the borrower. - Purchaser has immediate plans to resell the property for a profit. Restrictions against resale: Grantee herein shall be prohibited from conveying captioned property to a bona fide purchaser for value for a sales price of greater than ($ =120% of sales price) for a period of 180 days from the date of this deed. Grantee shall also be prohibited from encumbering subject property with a security interest in the amount greater than ($ = 120% of sales price for a period of one hundred eighty (180) days from the date of this deed. These restrictions shall run with the land and are not personal to grantee.

7 10. Contract Issues In REO sales, the buyer has little or no negotiating power. Standard contract addendums take away most of the rights a buyer takes for granted in a standard contract form. Despite the wide variation in real estate settlement practices among the states, national REO sellers, such as Fannie Mae, use a one size fits all form of contract in all states. It may contain provisions that apply only to certain areas of the country. Reps and warranties of the seller? Repair allowances? Post-closing adjustments? FUGGETABOUTIT! Specific disclaimer as to occupancy of the property: - If this is an FHA foreclosure, they do not guarantee the foreclosed owners have left the property. - If in a poor neighborhood, you might have homeless people who have moved in squatters. Closing waives all defects, including defective treatment for termites. - All costs to the buyer, including owner s title policy, recording, and escrow fees. - Most will prorate property taxes, but some REO sellers may require the buyer to take the property subject to property taxes. Seller s Debts and Liens Affidavit: REO sellers often object to language in standard sellers closing affidavits, stating that an REO seller cannot be expected to have knowledge of such facts. Often, these objections are understandable, and the proposed revisions to the affidavit are reasonable. Sometimes, the proposed changes are unreasonable (e.g., seller refuses to swear that it has no actual knowledge of any lawsuit against the seller). Seller may have complete ability to withdraw from contract and return earnest money without penalty. Time periods are often absolute, whether or not the buyer has your financing in place. Read the contract carefully!