Risks with Buying Bank owned Property

 

Buying a bank-owned property can be a good deal. But a buyer should be aware of potential title risks and how to minimize them.

A buyer in any real estate transaction typically has two forms of protection against title problems. First, the seller provides a deed containing a “warranty” against title problems, and the buyer can later sue the seller for breach of warranty if necessary. Second, the buyer obtains title insurance under which the insurance company agrees to assume responsibility for title issues except those specifically disclosed beforehand.

When a potential buyer of a bank-owned property makes an offer, the bank will typically require the buyer to agree to an “addendum” to the contract that supersedes the original offer and replaces many of its provisions — including title provisions — with terms more favorable to the bank. As for the deed, the addendum may indicate that the bank will provide only a “special” warranty deed rather than a “general” warranty deed — the difference being that the special warranty covers only title issues that originated during the short time the bank owned the property, but not before. If, for example, a neighboring property owner adversely possessed part of the property before the bank took ownership, this title problem would not be covered by a special warranty as it would with a general warranty because it occurred before the bank took title to the property.

A special warranty deed may be acceptable if the buyer obtains strong title insurance, but title insurance protection for a bank-owned property may also be lacking. In the customary process for non-bank-owned property, the seller will agree to purchase title insurance for the buyer from a local title company familiar with the area where the property is located. This familiarity makes it more likely that the title company will discover and disclose potential title matters for review by the buyer before closing. The title company will issue the policy on standard “ALTA” forms (that are generally acceptable to real estate practitioners) and agree to provide “extended coverage” for common title risks such as unrecorded easements, mechanics' liens, and encroachments.

Contrast this with the process for bank-owned property in which the addendum will often require that the buyer use a bank-designated title company that may not be familiar with the area … may not do a thorough job discovering and disclosing potential title issues before closing … may use non-ALTA forms with uncertain coverage … and may not agree to provide extended coverage, leaving the buyer exposed to unknown title risks. In addition, the policy may absolve the title company of liability in the event that the bank took title to the property through an improper foreclosure and the prior owner demands his home back (which has been known to happen).

So, how can a buyer of bank-owned property be protected? It's a matter of negotiation what the bank will agree to, but here are some suggestions:

1. Review the addendum carefully to make sure it is acceptable, particularly the parts that address title issues;

2. Get assurances that the title company will issue an ALTA policy with extended coverage and the bank's representation that it will provide whatever extra paperwork may be required by the title company to obtain this coverage;

3. Require a policy from a local title company (even if the buyer must pay extra); and

4. Ensure that the policy will not contain exceptions that eliminate coverage for improper foreclosure.

Given the complexity and risks, it's also a good idea to have a knowledgeable attorney review the transaction.

Noah Klug is principal of The Klug Law Firm, LLC, a general law practice in Summit County emphasizing real estate, litigation and business law. He may be reached at (970)468-4953 or Noah@TheKlugLawFirm.com.