Condo title-insurance alternatives: What lenders should know
Freddie Mac recently joined Fannie Mae in allowing lenders to use title insurance alternatives for condo and homeowners association units with the aim of offering loan cost savings; but the move also has raised questions about whether or not the substitution could put collateral at risk.
The influential government-related mortgage investors’ evaluation of the attorney opinion letters suggests AOLs can be similar to title insurance, and shave hundreds of dollars off the upfront cost of loans at a time when climate issues have raised the price of other types of coverage.
But the American Land Title Association, which represents insurers in this area, has warned broadly that the letters may not offer enough protection from lien conflicts that can be particularly dangerous for condominium units.
To help lenders make decisions about whether and when to use title insurance alternatives in conjunction with condo unit loans, NMN asked experts to share advice and information about the unique considerations in this niche.
First, it’s important to understand the broader context of the current condo market.
Potential savings amid lower prices and higher dues
It’s been three years since a Surfside, Florida, condo building collapsed, spotlighting concerns about the potential for similar issues with aging structures in this market, particularly in regions more prone to climate risks.
The government-sponsored enterprises have made many adjustments to their condo standards since Surfside. These were initially aimed at avoiding similar problems. Later, Fannie and Freddie added ways to make their updated underwriting more user-friendly in order to address complaints that it had limited access to this type of housing.
Subsequently, some community lender groups initially critical of GSE underwriting for condos have welcomed the introduction of some limited flexibilities, including the title-insurance alternative option.
The ability to finance condos has been important to community lenders and the enterprises because this type of shelter has a relatively affordable purchase price in what’s been a high-cost housing market.
“Prices of all properties have been up, but I would say condos less so,” said Doug Duncan, chief economist at Fannie Mae, in a recent interview with this publication.
The median sales price for a condo unit has been around $341,000 as compared to $419,000 for a single-family home, New American Funding found in a recent study.
However, condo owners also pay association dues and these, on average, have risen 20% in the last two years, according to Rexera data reported by the Wall Street Journal.
That increase is due in part to building concerns related to having enough resources to pay for maintenance and avoid a Surfside-like disaster; but they also stem from the condo sector’s particular exposure to higher taxes and rising homeowners insurance costs seen market-wide.
The fact that condos often are in states like Florida that are more likely to be exposed to natural disaster risk means they may be particularly prone to face higher costs for coverage, or have difficulty obtaining sufficient property insurance in line with the GSEs’ standards.
So the potential ability to replace title insurance, a separate form of coverage, with a cheaper option is one of the few areas where a price break may be possible.
The savings may look small relative to some other loan costs. Title coverage that protects ownership rights is typically a single expense paid upfront. In comparison, insurance that provides some protection against property damage must be maintained over time.
That said, title insurance alternatives could be seen as valuable considering that every little bit of savings counts in a pricey market, particularly for a borrower investing in a condo unit for affordability reasons.
Not only can title insurance alternatives save borrowers hundreds of dollars in some areas, in certain states that tend to have high insurance costs and volumes, savings from AOLs use can be as high as four figures, according to some advocates.
“It’s $2,000 or $3,000, on average in Florida and Texas. That makes a big difference,” said Stacy Mestayer, president of Alita Group, a provider of a digital platform that hosts contracts and other services used by letter providers.
However, insurers say it’s important to look beyond the upfront costs of a loan and also size up the lien risk that title searches are done to address.
In that context, another consideration for lenders is whether a potentially cheaper alternative to title insurance can provide adequate lien protection.
A specialized super-lien risk
A big question when it comes to condo units and title insurance alternatives is whether or not foregoing a more traditional type of risk management increases the potential exposure to a super lien, which trumps all others.
There are some super liens all properties could face, most notably those that are tax related. However, condos are different in that an association also may be able to place this type of lien on a unit if the owner isn’t paying dues or other obligations.
“There are unique risks when it comes to a condo, HOA or any other planned community. In a large number of states, the law allows for the creation of a super lien that could go above a first mortgage lien if you don’t pay your fees,” said Steve Gottheim, ALTA’s general counsel.
Fannie and Freddie have said that the protection offered by attorney opinion letters is similar to that offered by traditional title insurance in the condo space to the extent that AOL providers meet strict standards the GSEs have for counterparty/professional liability coverage.
However, ALTA contends that searches for condo super liens are particularly tricky and challenging to perform effectively at a low cost.
Other types of super liens outside the condo sector, such as those connected with unpaid property taxes or Property Assessed Clean Energy loans, might be found in the public record.
The dues-related ones on condos are another matter, said Gottheim. Locating such a lien on a condo or HOA unit often requires a manual type of search, he said.
Self-managed associations are less likely to provide cost-effective access to records. While the majority of associations work with professional management companies, a large percentage don’t.
“When you’re trying to automate the whole process, it becomes really hard in the condo and HOA space,” said Gottheim. “About 40% of HOAs are self managed and there’s no online access to figure out how to send a request for how much a unit owes.”
Almost 30% of title insurance losses and claims can be tied back to issues not found in the public record, statistics from Milliman show.
An AOL provider also has professional liability/counterparty insurance policies to address liens undiscovered in the title search process.
However, ALTA has raised the question of what happens if the insured party in question is no longer in business. It noted that AOL providers aren’t regulated by the states the way insurers are. Its representatives also have noted that the amount of coverage may vary by policy type.
“In the attorney opinion letter, that resource is not available in the same comprehensive manner to cover that potential oversight or risk of not catching those super liens,” said Christopher Morton, a senior vice president at ALTA responsible for advocacy efforts and public affairs.
What advocates of title insurance alternatives have to say
Advocates of insured attorney-opinion letters say the differences are minimal between coverage they provide in line with the GSEs’ standards and traditional insurance.
“There’s a very, very small fraction of a percentage of things that title insurance covers that insured AOLs don’t,” Mestayer said. “As for the cost differential, that can make a difference to borrowers.”
Lenders should be aware there are three standard risks that letter providers have to include in their agreements to meet Fannie and Freddie’s requirements, and the dues-related super lien risk is one of them, she added.
“They require a letter to say that there’s no violation of any restrictive covenants that are contained in the document, that all dues are current and not delinquent, and that there’s no recorded right of first refusal to purchase the land recorded in the public record,” Mestayer said. “Those three things should be confirmed by the law firm issuing the attorney opinion letter.”
While the dues-related lien risk for condos may make them riskier in one sense, they may be safer when it comes to other ownership risks such as the building’s claim to land. The association may have more resources to defend itself from lien conflicts than a homeowner.
“One advantage to condos might be the strength of a well-managed and capitalized HOA,” said Ted Sprink, managing director of iTitleTransfer, a company that provides risk assessments aimed at helping to determine whether and when traditional insurance is necessary.
Sprink advises lenders to be wary of different types of insurance offered to make sure it’s coverage they really need and that it’s worth the cost. He noted that lenders also should be aware there could be coverage time limits, and insurers may deny or force litigation of claims.
While title insurance alternatives might not be appropriate in all situations, some think they may be used more frequently now that Freddie and Fannie both have aligned standards that make it more efficient for lenders to use them not only in terms of cost but in terms of their workflow.
“Since they both have opened this up to HOA properties, we’ve seen a lot more lenders start the implementation process,” Mestayer said.
