Undisclosed fines and liens on a property are a nightmare for lenders and homeowners. Now add on to that the fact these liens are not covered under the traditional ALTA title insurance policy.
This is the case with municipal code violations, which could then come up to bite property purchasers and their mortgage lien holders. These are typically not recorded on government property records.
Code Violation Services Inc., Denver, has created CVD Plus, a disclosure report that makes lenders aware of these code violations, enabling them to make a smarter underwriting and approval decision. And it is not only on abandoned properties that lenders have to worry about these situations.
These violations could eat into the property's equity if they are not corrected. For example, said Rudy Krupka, chief executive, a Chicago family purchased a $125,000 home, only to find after closing that there are $40,000 of unrecorded code violations that transferred to the new owners.
As a result, the lender could end up with a defaulted mortgage if the situation isn't remedied. And typically, said both Krupka and Kim Hartmann, president of CVS, these violations are senior to the first lien mortgage on a property.
While CVS sees this as a potential problem, right now there is isn't a lot of data on how it affects the marketplace. But there is anecdotal evidence including one asset manager who asked for a search report post-closing. When asked why do a report on an asset they no longer owned, they told Krupka $50,000 worth of code violations on a $100,000 property in Chicago were discovered and the buyer is suing everybody.
Krupka has many years of experience in the default services arena in the Denver area. Eventually he would form Code Violation Services.
"We have a unique niche in the default services arena that actually goes substantially beyond default services," he said, listing such clientele as hedge fund traders, due diligence firms, loan originators, servicers, Realtors, consumers and even title, escrow and closing services companies.
Its services focus on management of risk exposure and collateral loss in the area unrecorded code violations for its clients. More and more municipalities are enacting laws in this area in part to find the owner of record of these properties (which are more likely than not to be abandoned) and to fight the associated issues with code violations such as neighborhood blight and loss of property tax revenue.
For example, the Chicago City Council, with the support of Mayor Rahm Emanuel, changed city law to impose liability on lenders, even before they foreclose on the property and take possession, for housing code violations.
Those that perform title searches are not actively looking for this type of information, Krupka said; in fact, in Schedule B of the ALTA title policy (which is the industry standard), the exceptions note that municipal government violations that have not been satisfied are not covered.
Hartmann said CVS is taking the CVD Plus report product out of the default space and into the traditional retail housing sales and loan origination businesses.
This product is good also for refinance transactions, she said; CVD Plus is a supplement to the traditional title insurance policy. Hartmann cautioned this is not title insurance, but merely "a report of the off-record matters which gives [originators] assurance, to help them see what title insurance is not covering."
The issue of lenders having to deal with these kinds of unrecorded liens will become more prevalent going forward, Hartmann said. "It is only in recent years that these unrecorded code violations have come to forefront," as the vacant property registration process started in 2008, she explained.
There is no data yet on what lender/servicer experience has been regarding these unrecorded liens.
Krupka added that properties in default and foreclosure have a higher propensity to receive an unrecorded code violation from the municipality where they are located that a property that is maintained and occupied.
Code enforcement personnel are stretched thin as is and are focusing their efforts on bank-owned properties.
"From a national standpoint, we see anywhere between 20% to 25% of properties that we research have some code violation associated with it. But there are states and neighborhoods that have substantially higher percentages of unrecorded code violations," he said, not only in areas with high foreclosures, but in those municipalities that are proactive and sophisticated in their code enforcement.
He pointed out that in Florida, 70% to 80% of REO properties have some level of unrecorded code violations.
The question that needs to be addressed, Krupka said, is who is ultimately responsible for dealing with these code violations? A lot of servicers and asset managers have in their contracts "sold as is" clauses and passing them through the process.
"Ultimately either a Realtor who didn't do due diligence or a borrower will bear the brunt of these unrecorded code violations," he said, but ultimately, they can harm the loan originator or investor.
This is because on a growing number of properties, the fines associated with the code violations have grown to be a substantial amount of a property's value (additional penalties are assessed as fines remain unpaid over a long period of time), which in turn reduces the equity position of the borrower and thus lenders need to be worried about this.
Those violations can be resolved, but he continued, what is the ultimate value of the property after all is said and done. Is the lender being opened up to additional exposure when it comes to the value of the collateral securing the mortgage? Krupka asked. It is possible some purchasers, after discovering how much they could owe as a result of these liens, would walk away from the property.
"Most lower-end properties are going to be the ones which will have substantially more code violations than a midlevel or higher-end property. Those are also the buyers who don't have the financial wherewithal to address these, let alone the knowledge or potential sophistication to negotiate these," Krupka pointed out.
