What's a Buy and Bail?
By Lisa A. Tyler
National Escrow Administrator
In markets hit hard by plummeting home prices and rising foreclosures, the real estate industry has discovered a phenomenon known as the "buy-and-bail." In a buy-and-bail transaction the borrower is up-to-date on the mortgage, but the value of his or her home has fallen below the amount owed. This is called an "upside down" mortgage. The borrower continues to make payments on the upside down mortgage secured by his or her first home, while applying for a purchase money mortgage on another home, usually at a substantially lower price than the first home. The borrower typically tells his or her new lender that the original property is pending sale, or tells the lender one of the two properties will be rented as an investment property.
The loophole works as follows: The homeowner provides a rental agreement showing he or she will rent out the first home. The lender will allow rental income to cover as much as 75 percent of the mortgage payment on the first home when determining if the borrower can make payments on two homes, enabling homeowners to secure another mortgage they might not otherwise be able to afford. After the new property is secured, the buy-and-bail borrower allows the first home to go into foreclosure. Although the buy-and-bail owner's foreclosure will remain on his or her credit report for at least seven years, it is difficult to detect a buy-and-bail scheme prior to consummation of the new purchase. If the parties to the transaction disclose the scheme to the settlement agent, the new lender should immediately be made aware.
Another change related to today's real estate market is the growing number of real estate professionals who have put their expertise in dealing with lenders to work on helping troubled borrowers avoid foreclosure by negotiating loan modifications. As a result, our operations have been inundated with calls from the negotiators wanting us to act as bill collectors. Read "Loan Modifications" to learn how to avoid opening orders that might never close and do not involve the services of an escrow holder or the issuance of title insurance.
Pat Baldwin, escrow administrator from Fidelity's operation in Maricopa County, Ariz., also shares two stories with "Paying Off a Private Note" and "Indemnity Gone Wrong."
Lastly, on Nov. 17, 2008, the Department of Housing and Urban Development (HUD) published a final rule in its reform of the Real Estate Settlement Procedures Act (RESPA). While some of the more onerous provisions of the earlier proposed rule (including the closing script) have been removed from the final version, several remaining provisions impact the escrow settlement process. The new rule requires a closer working relationship with the lenders who provide residential transaction financing. Learn more at our live hands-on training events and our live Webcast training events. Sign up for an event at home.fnf.com under the escrow administrator's home page.
Brokers and other real estate professionals have found a new revenue stream…loan modifications. They offer to negotiate better loan terms on behalf of borrowers in default. Rather than taking money up front from clients, they ask the clients to place their money in an escrow trust account. Once the negotiation is complete and the borrower accepts his or her modified loan terms (indicated by signing the paperwork), the escrow holder is authorized to wire the money to the broker's account.
If a negotiator, for lack of a better term, attempts to open an "escrow" transaction for a loan modification, there are some questions our settlement employees need to ask, such as:
- Will the transaction require a title commitment?
- Will the transaction require document signing and notary services?
- Will a final policy of title insurance be required by the lender?
- What funds, if any, will be paid through escrow?
- Who will provide the modification documents?
If the negotiator does not require a title commitment and only wants to deposit his or her fees into escrow, the settlement employees need to take the opportunity to inform the customer that our offices do not offer any type of invoice-collection escrow service. If collection of his or her bill (which is typically $2,500 to $3,000) is truly all the negotiator wants, he or she should contact our wholly-owned subsidiary company, Contract Servicing at 800.523.9784, which might be able to accommodate the negotiator's needs.
Additionally, our settlement professionals should take the opportunity to educate the customer/negotiator of the perils of loan modification without title insurance. Most lenders do not realize that by extending the maturity date on an existing note and/or extending additional credit, it can jeopardize the lender's existing lien position. In other words, if there are junior lienholders of record and the existing first lender extends the credit or maturity date, it could potentially make the first loan a second or third loan. The existing first lender truly needs a title commitment in order to make an educated decision to modify existing loan terms.
If we are to handle the transaction, we must insist the negotiator at least buy a title commitment from us before making the decision to waive off title insurance. Viewing the report is the best way for the lender to determine whether or not it jeopardizes the lien position. If the lender elects not to insure the modification, an officer of the lending institution will need to execute the Waiver of Right to Purchase Title Insurance and an Accommodation Recording Instruction, although some lenders do not record the modifications.
Moral of the Story
Don't fall prey to transactions that do not involve escrow settlement services or title insurance. We do not want to act as a bill collector for the negotiator's fee or to lend legitimacy to an otherwise questionable transaction. Typically the instructions from the negotiator to the escrow holder call for the use of a HUD form of settlement statement, which we would never do. The instructions also call for a set fee amount, typically $325. In filed-rate states, we can not offer escrow services or title products without first reviewing our rate manuals to verify rates exist for such services or products.
Paying Off a Private Note
The number one reason for escrow losses is payoff errors. The risk of loss greatly increases when the payoff lender is a private party. Our settlement agents must have additional processes in place to mitigate the risk of loss when paying off private-party lenders.
Settlement agents paying off private notes through escrow must follow certain guidelines to protect the Company and its policy of title insurance to the new owner and/or lender:
- Verify the statement came directly from the payoff lender.
- Verify the property address on the statement matches the property in question.
- Verify the loan number and borrower name match the request.
- Look for the payoff statement expiration date.
There are basically three types of loans paid through our escrow closings:
||Institutional Loans – These are the most common payoffs made to large institutional lenders and have the lowest risk of future losses and claims to the Company. When paying off institutional lenders, the settlement agent is assured of a future release of lien. In these types of payoffs, the settlement agent closes with the release as a "to come" item. Most offices process a tracking form for future follow-up of the release. In some states legislation allows for a release of obligation to be recorded by the title insurer, if the lender does not release the lien within 30 days from receipt of payoff funds.
||Payoffs Through Account Servicing – Seller carry-back financing or private beneficiaries will often employ the services of an account servicing agent to collect and apply the installment payments, hold the original note and security instrument and, in most cases, a presigned release. The servicing agent prepares the payoff statement, collects the funds on behalf of the beneficiary and provides the release of lien.
These types of payoffs present a higher risk when the servicing agent is not owned by a title insurer. In California, for instance, there have been numerous indictments of servicers due to their failure to remit the funds to the actual beneficiaries and instead absconding with the money. For these types of payoffs the California offices have taken the following precautions when payoff of an account servicing agent is requested:
- Obtain a payoff statement executed by all beneficiaries.
- Obtain original release prior to closing.
- Pay the beneficiary direct, not the servicing agent.
||Private-Party Beneficiary – This is a payoff to a private party beneficiary that has elected not to use a servicing agent. These types of payoffs also present special risks to the closing and insuring company. To mitigate those risks our settlement employees must follow California's lead and first obtain a written payoff statement signed by all beneficiaries; and second, obtain a signed release from all beneficiaries BEFORE closing.
Our settlement agents must have the executed release prior to closing. If the beneficiaries are reluctant to provide the release, they may include a statement on their payoff demand that reads, "You may only use this release if you can tender the sum of $____________ as referenced in this payoff demand. Otherwise, this release is null and void and cannot be used, as no consideration was paid for the release."
One of our offices recently had to negotiate a claim from a payee (father) who had loaned his son money. The father had a deed of trust recorded against the son's property and the son was refinancing. The deed of trust to the father was clearly a requirement on our title commitment. There was a handwritten note next to the requirement that said "none due." We had NO written statement from the father and NO release from the father. We also paid NO money to the father at the close of escrow. A few months later, the father filed a claim against us for the payment in full of the son's debt and threatened to foreclose. Remember, we have recorded a refinance deed of trust to a new lender and we are obligated to clear the title to be certain the new lender is in first position.
We thought we were sunk because we did not follow some basic procedures relative to private notes and deeds of trust. However, upon thorough scrutiny of the file, we found a tiny letter that the father had signed and given to the refinance lender that said, "Son owes me no money, Love, Dad." We think the father gave this to the refinance lender so the son could proceed with the refinance. Fortunately for us, we were able to use this to our advantage to avoid a $25,000 claim. However, it DID cost us $2,500 to settle with the father.
All of this could have been avoided had our escrow officer obtained a payoff statement from the father, addressed to us, claiming he was owed no money. The escrow officer also should have had the father sign a full release BEFORE we would close the refinance.
Indemnity Gone Wrong
It has become industry practice that when a lien shows up in public record that was paid in a previous transaction handled by another title insurer, the new title company requests an indemnity agreement from the former title company. The agreement indemnifies the new title company against risk of loss associated with omitting the requirement without paying the lien. Find out how one office received an indemnity, failed to read it and proceeded to close, only to suffer a claim.
One of the title commitments issued from our Maricopa, Ariz. office required the release of item 8: a Deed of Trust in the amount of $75,000 payable to Benchmark Financial and item 10: a Deed of Trust in the amount of $42,100 to Active Finance Group, LLC.
The commitment was issued for an "all cash" transaction with the sales price of $80,000. In the processing of this transaction, the escrow officer wrote "indemnity" next to item 8. The indemnity agreement was ordered and received from Stewart® Title. Unfortunately, the indemnity was for item 10 – the $42,100 to Active Finance Group. Neither the escrow officer or the title officer noticed the indemnity was for the wrong loan. If the escrow officer had reviewed the indemnity, she would have discovered that Stewart Title indemnified us for the $42,100 loan and NOT the $75,000 loan.
The escrow file contained a payoff statement from Active Finance Group. The amount shown on the statement was paid from the seller's proceeds at closing even though the indemnity from Stewart Title showed they cleared this lien. Now, the buyer who is insured has informed us that Benchmark has started foreclosure on the property!
Obviously things are wrong in this transaction. The sales price of our property was $80,000 and the amount we should have paid off was $75,000. Instead we paid $42,100 and the balance minus the closing costs to the seller as proceeds. If Active Finance was cleared of their lien in a previous Stewart Title escrow transaction, they were paid twice and unjustly enriched by our second payment. The Active Finance folks are a private Limited Liability Corporation (LLC) and our offices are concerned that if we pursue a return of the funds they will not have any assets.
Our offices now have a claim that we have to clear up and a possible loss of $75,000 for the failure to pay off the Benchmark loan. We would then have to sue Active Finance if they were paid twice.
Moral of the Story
This story is a good reminder to carefully review indemnity agreements. Be sure the correct lien has been identified and have a full understanding of the transaction prior to closing. In this transaction, the seller probably would have had to come in with money in order to close – not receive more $30,000 in proceeds.