As Fannie Mae expands the use of Attorney Opinion Letters (AOLs) for certain condo and HOA properties, lenders may increasingly request closing transactions with an AOL instead of traditional title insurance. While this may seem like a simpler solution, it carries significant risks that lenders need to consider. This blog explores the key differences between AOLs and title insurance and outlines the potential pitfalls of using an AOL for closing a real estate transaction.

The Risks of Relying on Attorney Opinion Letters (AOLs)

Lenders are often tempted to use AOLs as a faster or cheaper alternative to title insurance. However, it’s crucial to understand the risks involved. Title insurance has a long history of protecting lenders’ investments by guaranteeing lien priority and covering unknown risks. In contrast, AOLs only cover known risks and do not provide the same level of protection. This leaves lenders vulnerable to hidden title defects that could lead to significant financial losses.

What Does Title Insurance Cover vs. an AOL?

Title insurance provides comprehensive protection against both known and unknown title defects, including hidden risks such as fraud, forgery, or impersonation. These are risks that an attorney’s review of public records cannot always uncover. On the other hand, an AOL only addresses known risks discovered during a public records search. This means that lenders who accept AOLs are essentially self-insuring, which exposes them to greater risk if issues arise later.

Why Lenders Should Think Twice About Self-Insuring

Accepting an AOL instead of a title policy puts the lender in a precarious position. Title insurance companies are regulated and licensed to cover specific risks, but AOLs lack this regulatory oversight. About one-third of claims under title insurance policies relate to issues that wouldn’t have been found during a routine public records search. Without the safety net of title insurance, lenders are left to bear the financial burden if something goes wrong.

Reimbursement Challenges with AOLs

Another major drawback of AOLs is the difficulty of obtaining reimbursement for losses. Lenders must meet strict conditions, such as demonstrating foreclosure or proving exhaustive efforts to recover the mortgage balance, before seeking reimbursement. In contrast, title insurance offers a much simpler process: the insurer directly pays the lender for covered losses, streamlining the recovery process.

The Broader Impact: How AOLs Could Shake the Industry

If AOLs were widely adopted, the entire lending landscape could become riskier. Warehouse lenders, who provide short-term funding for mortgages, might pull back from the market due to the increased risk. This could lead to reduced liquidity in the industry, reminiscent of the 2007-2009 housing crisis. In turn, homebuyers would face higher costs, as prices for newly originated loans could spike.

A Faster, Safer Alternative: ALTA Short Form Residential Loan Policy

For lenders seeking a quick policy, title agents can offer the ALTA Short Form Residential Loan Policy. This four-page document includes all the terms and conditions of the Long Form but is quicker to issue, providing a safer alternative to AOLs without sacrificing protection.

What Should You Do If a Lender Requests an AOL?

If a lender asks you to close a deal using an AOL, it’s essential to carefully evaluate the risks. Here are some questions to consider:

• Are you willing to accept the increased risk of closing an AOL deal?
• Would you sign a Closing Protection Letter (CPL) not backed by your underwriter?
• Are you comfortable closing a transaction based on title work you didn’t perform?

Potential Pitfalls for Title Agents

Title agents should be aware that closing an AOL deal can introduce several challenges, including:

• Errors and omissions (E&O) insurance may not cover title agents for AOL-related transactions.
• State licensing requirements might restrict the types of deals title agents can close using AOLs.
• Certain states may have limitations on what products title agents can handle.

Conclusion: Why Title Insurance is Still the Best Choice

While Attorney Opinion Letters may seem like a convenient alternative, they come with significant risks for lenders, title agents, and consumers alike. Title insurance remains the gold standard for protecting against both known and unknown risks. It’s essential for lenders and title agents to educate clients on the advantages of title insurance and why it offers better protection than unregulated alternatives like AOLs.

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