As part of its goal to increase affordable mortgage access for homebuyers in the United States, Fannie Mae announced in December that it would accept attorney-opinion letters (AOLs) in place of title insurance with more mortgages. While AOLs have been allowed by the government-sponsored enterprise on select mortgages since 2022, the decision expands eligible mortgages to include condo units and properties with homeowners association (HOA) restrictions, potentially assisting more first-time homebuyers with the high costs of homeownership by trimming about $1,000 off their mortgage closing costs.
The Community Home Lenders of America expressed support for the alternative as a way to tackle homeownership affordability challenges. But the American Land Title Association (ALTA), the nation’s largest title insurance trade organization, has consistently pushed back against attempts to allow title insurance alternatives, citing gaps in protection for homeowners and lenders.
The association joined lawmakers from both political parties in criticizing an earlier pilot program that may have eliminated the title insurance requirement altogether on select mortgages. Fannie Mae abandoned the pilot program last year based on guidance from the Federal Housing Finance Agency (FHFA).
Though AOLs will now be an option for lenders originating many government-backed mortgages, critics claim lenders will need to sacrifice essential protections to make the alternative available to borrowers, which may limit the impact of Fannie Mae’s decision.
What Is Title Insurance?
First, it’s helpful to understand what title insurance is. This type of insurance protects against defects in the title that were present before the home sale but may threaten the buyer’s ownership rights or cause monetary losses in the future.
The vast majority of mortgage lenders require borrowers to purchase a lender’s title insurance policy with a limit that covers the mortgage principal. This means buyers must pay a sizable one-time premium at closing, which provides coverage until the mortgage is fully paid or the home is sold.
If issues with the title arise that challenge the buyer’s right to ownership, such as boundary disputes, unpaid real estate taxes, contractor claims, errors in property records, or fraud, these issues could put the lender’s security interest in the property at risk. The lender’s title insurance policy protects the lender against monetary losses in the event a third party successfully claims ownership of the buyer’s home. It does not cover the buyer’s legal fees or protect their home equity.
That’s why most attorneys recommend that buyers purchase an owner’s title insurance policy as well. These are often sold as a package. The owner’s title insurance policy typically covers the homeowner as long as they own the home.
Is Title Insurance Necessary?
Title insurance critics contend that attorney-opinion letters, which are now allowed on many mortgages backed by Fannie Mae and, in more limited circumstances, Freddie Mac, provide sufficient protection against title risks.
According to Fannie Mae’s guidance, attorneys issuing the letters must have errors and omissions insurance, which can protect against losses the lender incurs due to attorney negligence during the title examination. For example, SingleSource, which provides services to mortgage originators, now offers an Attorney Conclusion of Title that includes a transactional liability insurance policy that lists the lender as a third-party beneficiary and covers the loan principal for the length of the loan.
But if the buyer discovers title issues that are not due to attorney negligence, any resulting losses may not be covered. And foreclosure may need to occur before even filing a claim. It’s also not clear whether the buyer’s or lender’s legal fees would be covered in a title dispute or whether an AOL provides any protection against title issues related to fraud, according to ALTA.
For these reasons, lenders and buyers may opt for title insurance to get access to broader coverage for a wider range of title defects, even if a cheaper alternative is available. Some members of Congress have expressed concern about how AOLs will be marketed to homeowners and have asked the FHFA for clarification on what disclosures will be required to prevent consumer protection violations. Without proper education on the differences between title insurance and AOLs, homebuyers might not understand the protections they’re giving up to save money on closing costs.
That said, title issues are relatively rare. In fact, of the more than 10,000 AOL-supported mortgages that Fannie Mae has purchased since 2009, none have resulted in losses for the mortgage company. While title defects have caused homeowners to lose their properties in rare cases, mechanics’ liens are more common and not as catastrophic, according to the Urban Institute.
Reducing Title Insurance Costs
Despite the broad coverage that title insurance policies provide, many people criticize the high costs to consumers and how that money is spent. With most insurance products, providers spend about 70% or more of the premium dollars they collect paying out claims to policyholders. Title insurers, by contrast, only put about 5% of premiums toward covering losses.
Title insurance agents retain about 70% of buyers’ premiums, according to a report from the U.S. Government Accountability Office (GAO). While the role of the title insurance agent is sometimes labor intensive, in other instances, it can be mostly automated, with the title search and examination taking as little as 60 seconds.
The Consumer Financial Protection Bureau encourages homebuyers to shop around for a title insurance company since research shows comparison shopping can save consumers as much as $500 on title insurance. However, some people question whether real estate brokers or lenders may be steering homebuyers toward title companies with which they have Affiliate Business Arrangements (ABAs) that provide financial incentives.
For example, The Denver Post investigated 2,200 home sales for which real estate brokers had profitable partnerships with title companies and found that most homeowners chose the title insurance company that financially benefited their broker. Agents are required to register ABAs with the state of Colorado and disclose those relationships with homebuyers, but the investigation revealed at least three dozen agents with unregistered ABAs.
And there was evidence to suggest that even some brokers with registered ABAs weren’t giving their clients options. For example, 100% of three brokers’ home sales used their affiliate title insurance company. If brokers had provided homebuyers with three options to compare with each other, as industry protocol suggests, that outcome would be highly unlikely.
Title insurance typically costs about 0.5% of a home’s purchase price, which is more than $2,000 on a median-priced home. Even in the absence of affordable alternatives that provide sufficient protection for homeowners, the Urban Institute notes there are ways to control excessive costs. Self-insurance by secondary market entities, like the pilot program Fannie Mae dropped after backlash from the title insurance industry, could be one potential strategy.
State regulations can also make an impact. For example, the state of Iowa, which prohibits the sale of commercial title insurance, operates Iowa Title Guaranty, which provides similar coverage as a commercial title insurance policy to both the lender and the owner at a flat fee of $175 for properties that sell for $750,000 or less. Any surplus profits go toward Iowa’s housing program fund.
Iowa’s homebuyers are also required to pay for an attorney-abstract opinion, but they still pay far less than the typical title insurance premium in other states. Additionally, Iowa Title Guaranty won’t insure titles that haven’t been thoroughly examined by an attorney. Because this system has been in place for decades, the state is well known for its clean titles.
The Bottom Line
While $1,000 in savings may seem minor relative to the cost of buying a home, homebuyers today need any edge they can get. Research shows that even an extra mortgage payment’s worth of post-closing reserves can dramatically decrease the risk of default.
The FHFA requires Fannie Mae to make efforts toward advancing housing finance equity, which is a challenging task given high mortgage rates and high housing prices. Expanded acceptance of AOLs in place of title insurance is one aspect of Fannie Mae’s plan, but in some situations, forgoing title insurance could leave homeowners vulnerable to unaffordable costs down the road. Lawmakers and title industry advocates have been vocal about their concerns, and their criticism may impact lenders’ decision to allow the alternative.
Real estate investors may also continue to purchase title insurance, even if more affordable alternatives are available, in order to secure the broadest possible protection for their investments. But regardless of the impact of Fannie Mae’s decision, there may be room for further innovation and cost control measures related to title insurance.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
