Investors cannot expect to increase their loan purchases unless they have a system in place to check that all documentation behind each loan is correct.
The foreclosure document crisis may have died down in recent weeks, but the issue of proper loan documentation will continue to be a critical one for investors in the residential mortgage industry. Poor or inadequate documentation, bad title chains and missing loan assignments can prevent lenders from selling loans and properties, unnecessarily impede foreclosures, delay bankruptcy proceedings and confuse borrowers on what options they may have.
A recent judicial ruling really brings all this home. The Massachusetts Supreme Judicial Court in January threw out foreclosure motions by two banks even though there was no dispute that the borrowers had defaulted on their loans. Rather, the court based its ruling on the fact that the banks in question failed to show that they were the holders of mortgages at the time of foreclosure.
Two comments from the justices should serve as a chilling wake-up call for mortgage investors about what they had better do to protect themselves in such matters.
"There must be proof that the assignment was made by a party that itself held the mortgage," one justice wrote, adding that "a conveyance of real property, such as a mortgage, that does not name the assignee conveys nothing and is void." Another justice wrote that "the holder of an assigned mortgage needs to take care to ensure that his legal paperwork is in order" before commencing a foreclosure action.
If there is anyone still doubting the importance of getting the documents right, these court comments should dissuade them firmly.
The issue remains critical because the secondary market for "scratch-and-dent" mortgages is growing rapidly. In recent months we've seen hedge funds, small investment companies, even groups of attorneys, putting together funds to buy distressed mortgages. One of our clients is a small investor who normally buys a few mortgage loans each month. We recently received an order from him to check the documentation on about 350 loans. That's how the market is growing. Clearly they see a buying opportunity.
A thriving market for distressed assets will accelerate recovery in the housing and mortgage markets. But investors should not increase their loan purchases unless they have a system in place to check that all documentation behind each loan is correct, accessible and properly filed with the local recording agencies. Investors must be able to ensure that the loans they buy have proper documentation and that they can prove their ownership in court if they have to.
For investors, the name of the game is: Protect your investment. Indeed, many investors are taking this issue a lot more seriously than they used to.
Previously, ensuring proper documentation when a loan was transferred from one party to another was an informal affair, usually a conversation after the papers were signed about whose responsibility it was. No more. The buyer of the mortgage should take control of the process. You should insist on this in your negotiation. In fact, it is common to "escrow" an amount per loan to pay for having assignments drafted and recorded. It is also recommended you obtain signing authority from your seller to complete necessary paperwork on your new investment.
Once you buy a mortgage, you must make sure the loan has been properly assigned and registered in your name. If you cannot handle the compliance process yourself, hire a documentation professional to do it for you.
Making sure that the proper paperwork has been completed is critical. Buying a loan with bad or inadequate documentation sets you up for potential losses. You don't want to inherit trouble.
Bad or incomplete documentation or a title that is not in proper order can keep a company from selling a loan or greatly reduce the selling price. We've seen some investors pay as little as $700 for real estate owned properties because the loans had poor documentation.
They are only willing to pay that much because they know they have to invest a lot of money not only into the property, but also into cleaning up the title chain to transfer the home into their name.
Companies with REO properties on their books that are trying to get rid of them must put a process in place to prove they have clear title and can transfer the property to the new buyer quickly and efficiently. By doing that, and by simplifying the process for the buyer, they give themselves a better opportunity to increase the sale price on their portfolio.
Investors also run the risk that having proper documentation will be imposed legislatively, not just judicially.
The Dodd-Frank Act generally allows federal oversight of banks doing mortgage lending, so anything that raises questions of financial stability is subject to scrutiny. The law actually requires the creditor to verify income and documentation in determining "suitability," that is a borrower's ability to repay the debt.
Moreover, as consumer advocates, lawyers and industry participants review the 2,300-page act more closely, it is likely that many new compliance issues will be uncovered. Faulty or missing documentation is an open invitation for federal regulators to come in and look around.
Proper loan documentation is admittedly not the sexier side of the business, and it doesn't produce any revenue. That's why so many lenders and servicers chose to neglect it. But we've seen the results of that neglect and how costly it can be. In the long run, the proverbial ounce of prevention is definitely worth a pound of cure.
