The housing finance giants Fannie Mae and Freddie Mac represent 70% of the mortgage market. Most observers of the U.S. housing finance system would agree that Fannie Mae and Freddie Mac serve a vital role in providing liquidity to lenders, expanding credit, and improving market function. The primary role of the GSEs is to provide lending institutions with a mechanism to move loans out of their own portfolios, making dollars available to be lent to the next home purchaser. In serving this role, the GSEs have standards about what loans they will take out of the hands of lenders – they are limited in size, impose borrower credit qualifications, and have required that the home purchase includes title insurance, among others. These standards help to reduce risk in mortgage and housing markets and ensure that the Treasury is not exposed to a mass of bad mortgage debt as it was during the financial crisis.
The longstanding title insurance requirement for mortgages backed by the GSEs exists for good reason. Title insurance provides protection for buyers and lenders from financial loss that could result if there are problems with the transfer of a home’s title. Without title insurance, the buyer or lender could be exposed to liability from the previous owner’s back taxes, outstanding liens, fraudulent and disputed property claims, and any number of issues that arise with the legal transfer of title.
Last year, Fannie Mae announced that it would accept written attorney opinion letters instead of title insurance policies in limited circumstances. This decision aligned Fannie Mae’s Selling Guide with guidance its competitor Freddie Mac issued back in 2008. However, an attorney opinion letter, which is simply an opinion based on a search of the public record, does not cover so-called “unknown” or “hidden” risks that title insurance covers, such as fraud or forgery. And if an attorney opinion turns out to be incorrect, buyers and lenders would be left to fight over the consequences.
Fortunately, Fannie Mae only purchased 45 loans with attorney opinion letters out of the over one million loans purchased last year. However, if this program is expanded broadly, it raises questions about what would happen in the inevitable event that loans sold to Fannie have title problems that are not covered by attorney opinions. The expansion of this program could have a domino effect of negative unintended consequences in the housing and mortgage market.
If Fannie Mae chooses to expand attorney opinion letters, it will necessarily be the recipient of more mortgages that have a title problem. Without insurance as part of the transaction, more title defects will go unnoticed until after a home closing, pushing riskier mortgages into the Fannie Mae portfolio. In addition, it’s the curative work performed by title professionals that reduces risk and minimizes claims lenders experience. Some of these mortgages may be returned to lenders, changing the risk-reward proposition for mortgage lenders and pushing fees and interest rates higher. Others may be remedied in ways that could affect the value of the homes that exist in Fannie’s mortgage portfolio or that get passed on to the secondary market. Either way, this introduces more risk to the housing and mortgage market, the cost of which will be borne by a combination of taxpayers, borrowers, and lenders.
Further, while title insurance is regulated at both the state and federal level, there is no clear regulatory authority at the state or federal level that oversees attorney opinion letters. Title insurance policies are also backed by statutorily required financial reserves to cover future claims risks, and attorney opinions have no such requirements. There are many questions remaining about whether these products would eventually be subject to regulatory oversight and who, if anyone, is overseeing these products in the meantime.
Although the providers of these alternative products call attention to the cost savings that these products would supposedly generate for homebuyers at closing, many consumers would pay more in the long run by taking on additional risk and potentially losing various coverages of a title insurance policy if a title dispute were to occur.
There are several practices and programs that help reduce costs for homebuyers at closing. In over half of the states, the seller pays for part or all of the cost of the owner’s title insurance policy. Meanwhile, the buyer pays a nominal amount for a policy to protect the lender. In addition, there are simultaneous issue discounts that lower the cost of coverage when the owner’s and lender’s policies are issued together. Reissue rate discounts also are available on a lender's policy for refinances. These practices and programs help reduce closing costs without introducing more risk into the market.
The FHFA is responsible for regulating Fannie Mae and Freddie Mac and should be carefully considering how a move away from requiring title insurance would impact the housing, mortgage, and insurance markets. Inducing risk in mortgage markets is largely what caused the housing crash and financial crisis; mitigating risk in these markets is what guided us out of that era. Title insurance requirements help ensure that risks are contained and that costs are shared among all who benefit from this insurance, providing a market-based way to reduce risk in housing and mortgage markets, and protecting both homebuyers and taxpayers.
