As the foreclosure documentation scandal grows, buyers who purchased a distressed property in recent years may wonder if they really own their home.
After all, if the foreclosure was improperly handled, the previous owners could file a lawsuit against their lender and the attorneys who handled the foreclosure.
The good news is that legal experts say there is little risk such purchasers would lose their homes or become liable for financial compensation to the foreclosure victim.
"The biggest protection is the 'bona fide purchaser' law that protects buyers from getting in trouble if they could not have known there was a problem with their purchase," says Jonas Jacobson, an attorney and principal with the Law Offices of Jonas Jacobson in Boston.
"For example, if you unknowingly bought a stolen car and had no reason to know it was stolen, you could not be prosecuted for buying that car. In addition, most states have a relatively short statute of limitations on real estate transactions."
Small chance of lawsuit
Steven Horne, an attorney and president of Wingspan Portfolio Advisors in Carrollton, Texas, agrees there is little danger of homeowners losing homes due to foreclosure paperwork mistakes.
However, there is a small chance a homeowner who bought a foreclosure could become involved in a lawsuit, he says.
"The previous owner or perhaps a second lien holder who was not paid off by the foreclosure sale could challenge the validity of the sale," Horne says. "But they would have to prove that the foreclosure was wrongful and that the previous owners could have afforded to keep the house."
Horne says the most likely outcome of mishandled foreclosures is financial compensation paid to the foreclosure victims by their lender or title insurance company.
"It would be extremely unusual for a judge to unravel a deal," Jacobson says. "In addition, most foreclosure victims do not have the money to file a lawsuit or the money to make the house payments if the home was returned to them."
Horne says state laws dictate how potential foreclosure disputes unfold, with homeowners well-protected in most states.
Taking protective steps
Although most buyers have little to fear, the recent chaos surrounding sales of distressed properties highlights the importance of protecting yourself when purchasing a foreclosure.
According to RealtyTrac, 29 percent of all home purchases in 2009 were foreclosures and 31 percent of all home purchases in the first quarter of 2010 were foreclosures.
Joseph Gentile, an attorney and vice president of Federal Title & Escrow Co. in Washington, D.C., says a wrongful foreclosure is the perfect example of why homebuyers should buy owner's title insurance.
Owner's title insurance, which is optional, directly protects the homeowners in a title dispute. Gentile says 99 percent of buyers choose to purchase optional owner's title insurance. (Mandatory title insurance, paid for by the buyer at settlement, protects the lender in case of a title dispute.)
"Owner's title insurance protects you from any defect in the title," Gentile says. "If a judge would determine that the foreclosure was not valid, then the title insurance company would have to work out the problem, not the homeowner."
Gentile says it is "extremely unlikely" that homes will be taken away from new owners and returned to the previous owners.
"But if that did occur, then the homeowner would be protected (by title insurance) up to the full value of the property," Gentile says.
Check your policy
For that reason, homeowners should know their title insurance status.
"I would recommend that homeowners who bought a foreclosure within the past few years check for their title insurance policy to be sure they bought it," Gentile says. "Some people don't even realize they purchased it."
Gentile urges owners who cannot find their policy to contact the settlement company from their closing and find out their title insurance company's name.
Homeowners who did not purchase owner's title insurance can purchase it now.
"A new title search would have to be done on the property, and it would likely be a little more costly to purchase this insurance after settlement. But it is possible to buy owner's title insurance at any time after settlement," Gentile says.
Jacobson recommends homeowners review their settlement documents and contact their settlement attorney for reassurance.
"Everyone should always have their own attorney representing them at settlement -- and if you don't have one, you might want to hire an attorney now to review your documentation," Jacobson says.
Future sale of the home
One area of future uncertainty is how title insurance companies will handle insuring these properties going forward.
"The current title insurance company will continue to insure the title on the property, but it is a possibility that when the home is sold, a new title insurance policy would be more difficult to obtain," Gentile says.
Given the large number of foreclosures, title insurance companies will likely find a way to provide insurance in the future, Horne says.
However, he recommends that owners who need to sell soon contact their title company now to discuss any potential problems with the sale.