Title, Liens and Due Diligence on Distressed Properties

Title is your legal ownership of a property. A clear or marketable title is one free of significant defects, liens or competing claims, so you can live in, borrow against or sell the home without challenge.

Due diligence is the research you do to confirm what you are buying before you are committed. On a distressed property it typically covers three areas:

• Title and liens: who owns the property, what debts are recorded against it, and which of those will remain after your purchase.
• Legal status: where the property is in the foreclosure process, whether the sale could be postponed or challenged, and whether any redemption rights apply.
• Physical condition and occupancy: what repairs are needed, whether anyone lives there and what it will take to gain possession.

In a standard financed purchase, much of the title work is handled for you: the title or escrow company searches the records, issues a title commitment and requires problems to be fixed before closing, as described in the guide to closing and recording. Distressed purchases are different. At a foreclosure auction there is usually no closing process at all, so the bidder must do this work in advance. Even on REO purchases, the deed you receive and the seller's promises about title may be more limited than in a normal sale, as the section on deeds below explains.

A title search reviews public records, mainly at the county recorder or clerk, to trace the property's ownership history and identify recorded claims. A thorough search typically looks for:

• The chain of title: each transfer of ownership, to confirm the seller actually owns what they are selling.
• Mortgages and deeds of trust, including second mortgages and home equity lines.
• Liens, such as tax liens, judgment liens, mechanic's liens and HOA liens.
• Lawsuits affecting the property, often shown by a lis pendens.
• Foreclosure filings, such as a notice of default or notice of sale.
• Easements, covenants and restrictions that limit how the property can be used.
• Unpaid property taxes, usually checked with the county tax collector, which may be a separate office.

Searches have limits. They cover recorded documents, so unrecorded claims, forged signatures, filing errors, missing heirs and some boundary problems may not show up. That gap is what title insurance is designed to cover.

You can look up some records yourself on many county websites, which is useful for early screening. For a property you intend to buy or bid on, a professional search from a title company or attorney is far more reliable, because interpreting lien priority and the effect of a foreclosure is technical work.

When a lender forecloses, the sale generally wipes out liens that are junior to, or lower in priority than, the loan being foreclosed, as long as the foreclosure was carried out properly. Liens that are senior to that loan generally survive and stay attached to the property. Priority is usually set by recording date, but state law gives some liens special priority.

This is a simplified overview. Whether a specific lien survives depends on state law, the order of recording, the type of lien and whether the foreclosure followed the required steps.

When and how you check title depends on how you are buying.

• Pre-foreclosure and short sale. In a pre-foreclosure or short sale, the owner still holds title, so the purchase can follow a normal closing with a title search and title insurance. The challenge is that every lienholder must be paid or must agree to release its lien. In a short sale with a second mortgage, each lender usually needs to approve. Start the title search early, because a lien you discover late can stall approval.
• Foreclosure auction. At a foreclosure auction, you must research title before the sale, typically at your own cost, because the purchase is usually final and you cannot cancel over a title problem. Identify which loan is being foreclosed, what liens are senior to it, whether property taxes are owed and whether any redemption right applies after the sale. The guide to researching a property before auction walks through this process.
• Bank-owned (REO). On a bank-owned home, the lender's foreclosure should have cleared junior liens, and a title company will search again before closing. Still review the title commitment closely: problems from the foreclosure itself, unpaid taxes or municipal liens can remain. Read the bank's addenda to see what the seller will and will not fix.

For any purchase, ask for the title commitment as early as possible and read the list of exceptions and requirements. Anything listed as an exception is something the title policy will not cover.

Title insurance protects against financial loss from covered title defects that existed before you bought the property, such as an unknown lien, a forged deed in the chain of title, an error in the public records or a claim from a missing heir. Unlike most insurance, you typically pay a single premium at closing, and the policy lasts as long as you or your heirs own the property.

There are two kinds of policy:

• Lender's policy. Protects the lender up to the loan amount. Lenders almost always require one when you take out a mortgage.
• Owner's policy. Protects your own equity, up to the purchase price. It is often optional, though in some areas the seller customarily pays for it.

On properties with a foreclosure in their history, an owner's policy is particularly worth considering. Foreclosures involve many notices and legal steps, and a defect in any of them can lead to a later challenge.

Beyond the exceptions in the commitment, the policy also has standard exclusions, and some insurers may decline to insure a property bought at auction until certain issues are resolved, such as the end of a redemption period. Ask about this before you bid if you plan to resell or refinance quickly.

Title premiums and who pays them vary by state and local custom. The guide to closing costs covers how title fees appear on your closing documents, and the guide to closing and recording explains when the policies are issued.

The type of deed you receive tells you what promises the seller is making about title.

• General warranty deed. The seller guarantees title against defects arising at any time, including before they owned it. This is common in standard sales in many states.
• Special or limited warranty deed. The seller guarantees only against defects that arose while they owned the property. Many REO sellers use this type.
• Trustee's deed or sheriff's deed. Issued after a foreclosure sale. These generally carry few or no warranties about title.
• Quitclaim deed. Transfers whatever interest the grantor has, if any, with no warranties at all.

The fewer the warranties, the more you rely on your own research and on title insurance.

Some states also give the former owner, and sometimes junior lienholders, a right of redemption: the right to reclaim the property after the foreclosure sale by paying the amount required by law within a set period. Whether a redemption right exists, how long it lasts and what must be paid all vary by state and by the type of foreclosure. During a redemption period, the buyer's ownership can be undone, which affects whether you can renovate, insure or resell.

Find out whether a redemption right applies before you bid or buy, and factor the waiting period into your plans and budget.

Title research tells you what you legally own. You also need to know what you are physically getting.

Occupancy. Find out whether the former owner, a tenant or anyone else lives in the property. A foreclosure purchase does not let you simply change the locks; removing occupants generally requires following your state's legal process, and tenants may have additional protections under federal, state or local law. Some buyers negotiate a cash-for-keys agreement, paying occupants to leave by an agreed date in good condition.

Condition. Where you can inspect, hire a qualified inspector. Where you cannot, as at most auctions, look at the exterior, review listing photos and permit records, and talk to neighbors where appropriate. Vacant homes are vulnerable to frozen pipes, water damage, theft of fixtures and vandalism.

Code and permit issues. Check with the local building or code enforcement office for open violations, unpermitted work or condemnation orders. Fines and required repairs can become your problem.

Utilities and HOA. Ask whether utilities are connected and whether unpaid utility or HOA balances could become your responsibility.

Build what you learn into your offer or maximum bid. The auction bid calculator helps you subtract repairs, surviving liens and holding costs from a property's value.