Foreclosure Freeze May Sideline U.S. Homebuyers on Legal Concern

A halt in home foreclosures at the largest U.S. mortgage firms may sideline buyers worried about legal issues, further depressing sales at a time when distressed properties account for almost a quarter of all transactions.

Revelations of mistakes in foreclosure proceedings are causing buyers to have misgivings about property titles, the right of home possession, said Richard DeKaser, chief economist at Woodley Park Research in Washington. Confidence in the legality of repossessions will cut foreclosure sales more than a reduction of available properties because the market already is flooded with repossessed homes, he said.

“The legal problems we’re seeing will hit sales as people worry about the legitimacy of the process,” DeKaser said. “The implications are that there’s been shoddy work.”

Bank of America Corp., the largest U.S. lender, extended a freeze on foreclosures to all 50 states Oct. 8 as concern spread among federal and state officials that homes are being seized based on faulty data. JPMorgan Chase & Co. and Ally Financial Inc.’s GMAC Mortgage unit stopped repossession cases in 23 states where courts supervise home seizures, amid allegations that employees submitted documents with unverified or false information to speed the process.

Nevada, Arizona

Foreclosure sales accounted for 24 percent of all home transactions during the second quarter, according to a Sept. 30 report by RealtyTrac Inc., an Irvine, California-based data seller. They made up a greater share in the states hardest-hit by the housing crisis, accounting for 56 percent of purchases in Nevada, 47 percent in Arizona and 43 percent in California.

In Florida, Massachusetts, Michigan and Rhode Island, the share was about a third.

Some indicators show the U.S. real estate market had turned a corner in August. The number of contracts to purchase previously owned homes increased 4.3 percent, the second monthly gain, according to an Oct. 4 report from the National Association of Realtors. Sales of previously owned homes rose to an annual pace 4.13 million, up 7.6 percent from July’s record low, the Chicago-based group said last month. September sales likely won’t be affected by the foreclosure legal problems.

“Our preliminary review of September foreclosure activity doesn’t show any obvious or notable impact,” said Rick Sharga, senior vice president of RealtyTrac. The effects may show up in the October data, he said.

PNC Halt

In addition to the freezes by Bank of America, JPMorgan and GMAC, PNC Financial Services Group Inc. halted sales of foreclosed homes for a month to review documents in its mortgage servicing procedures, according to an Oct. 4 memo the bank sent to lawyers handling the lender’s foreclosures.

Litton Loan Servicing LP, a mortgage-servicing business owned by Goldman Sachs Group Inc., said last week it’s stopping some foreclosures to review how they’re handled. Vickee Adams, a spokeswoman for San Francisco-based Wells Fargo & Co., and Mark Rodgers, a spokesman for Citigroup Inc. in New York, said the companies are still processing foreclosures.

A reduction in foreclosure sales may result in a short-term boost to the nation’s median home price as buyers shy away from distressed properties, said Thomas Lawler, founder and president of Lawler Housing and Economic Consulting in Leesburg, Virginia.

In the second quarter, distressed homes -- those that had received a default or auction notice or were seized banks -- sold at an average 26 percent discount to properties not in the foreclosure process, according to RealtyTrac.

Temporary Boost

Any short-term boost to prices may be offset when a flood of properties are offered for sale after document problems are sorted out, Lawler said.

“Some people are breathing a short-term sigh of relief because the likelihood of distressed sales putting downward pressure on home prices has been put off,” Lawler said. “But no one is breathing a long-term sigh of relief because when these properties eventually come on the market, we’ll have both the confidence problem and the price problem.”

U.S. home seizures climbed to records in three of the last five months, RealtyTrac said Sept. 16. Banks seized 95,364 homes in August and issued foreclosure filings to 338,836 owners, or one of every 381 U.S. households, according to the company.

It isn’t known how many loans are included in the national review by Bank of America, said Sharga. Before the Oct. 8 announcement, as many as 200,000 properties were included in the 23-state freeze by the Charlotte, North Carolina-based bank, New York-based JPMorgan and GMAC of Detroit, he said.

‘No Excuse’

“The broader concern is that if banks took shortcuts here, what else did they do?” Sharga said. “Five years into this crisis, there’s no excuse for not having a process in place.”

A study of foreclosure court documents by Richard Kessler, an attorney in Sarasota, Florida, found errors such as missing or improperly handled documents in about three-fourths of the cases. The mistakes may allow former owners and other claimants to contest the legality of pending and previously completed foreclosures, he said.

Ownership questions may not arise until a home is under contract and the potential purchaser applies for title insurance, or even decades later as one deed researcher catches errors overlooked by another. A so-called defective title means the person who paid for and moved into a house may not be the legal owner.

In cases of lost or mishandled paperwork, attorneys in many cases are allowed to refile documents to correct omissions and establish a claim, said Kathleen Engel, a financial-services law professor at Suffolk University in Boston.

Most of the homes affected by the foreclosure freeze will eventually come on to the market because the dispute is about court documents, not about whether borrowers defaulted, said Lawler, the housing economist.

“Most of the delays will just be delays,” Lawler said. “All this is doing is creating severe uncertainty for people who were thinking of buying a distressed property.”

To contact the reporters on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net; Dan Levy in San Francisco at dlevy13@bloomberg.net

To contact the editor responsible for this story: Kara Wetzel at kwetzel@bloomberg.net.

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