Mortgage lenders face significant financial risks at the closing of each loan. The risks include acts or omissions by several parties, involving borrowers, sellers, attorneys, title agents, real estate agents, and even notaries. Errors in document execution, document recording, lien payoffs, funds wires, mishandling of PII, and outright theft of funds can impact every single transaction.
Historically, lenders have addressed the offset of financial losses in two ways: title insurance and the closing protection letter. Lenders who implement a high level of counterparty risk management also ensure errors and omissions, and cyber insurance policies are in force for closing agents. Are these effective and enough?
A title policy insurance has been and continues to be an effective method of managing risk from lien position issues and title issues. The statistics reflect that there are very few title claims because title agents do a good job researching and addressing lien and title issues. The greater problem is what happens when an attorney, title agent, or escrow officer mismanages a lender's document execution, the distribution of lender proceeds, satisfaction of existing liens, and other errors. If title itself, that is ownership is not impacted; these issues generally fall outside the title policy.
Where closing fraud or errors occur, which can impact a lender, its loan file, the ability to sell a loan, and the potential loss of mortgage proceeds, as well as reputational harm, a lender has less reliable sources of offsetting financial losses. Lenders face incredible hurdles trying to have documents re-executed, corrected, and refiled post-closing. Once the parties leave the closing table, coordinating their efforts to fix problems becomes a time-consuming task. Furthermore, the rise in wire fraud incidents, which are much better managed by lenders today than their counterparts, creates risk of significant financial loss where an attorney, title agent, or escrow officer is duped into sending funds electronically to a criminal who is not the intended party.
When issues arise directly related to settlement and funding, a lender's option to recover losses turns on: (a) the closing protection letter (CPL), (b) the agent’s E & O policy, (c) the agent’s cyber-crimes policy or endorsement, and (d) the agent’s surety bond, if any. Because no state requires real estate attorneys to purchase E & O or Cyber coverage, and the requirement for surety bonds varies by state and involves nominal coverage amounts, these fall flat in the face of a significant loss. Most lenders today have no idea whether an agent even carries active insurance, let alone the policy limits and exclusions.
The CPL is not an insurance policy. It is merely a form of warranty letter, in which the title insurer behind the agent agrees to cover certain losses where the settlement agent (this may be an attorney or the title agent) causes certain harm. It is not governed by insurance laws, does not have a regulated claims process, and is typically vigorously defended by the title insurers. Lenders routinely report difficulties seeking recovery for losses when making a claim against a CPL.
Where does that leave lenders and consumers who pay for the CPL? In search of a better solution. Next month I will take a deep dive into alternatives (not the AOL) which may transform the closing industry and offer every party impacted by risk of loss at the settlement of a mortgage loan, a true remedy for offsetting losses.
