Mortgage investors in at least two states are at risk of total loss on loans where a homeowners association forecloses on the property without any notice to the first mortgage holder.
In September, the Nevada Supreme Court ruled that a first deed of trust can be extinguished when an HOA forecloses its lien.
In its decision, the court called the HOA lien a true super-priority lien and noted that the Nevada HOA lien statute is based on the Uniform Common Interest Ownership Act of 1982.
The ruling followed a similar outcome a month earlier in Washington, D.C.
A report from Morningstar Credit Ratings LLC indicated that the Nevada decision is forcing participants in the residential lending market to examine their HOA exposure.
The ratings agency explained that the HOA in the case was owed just $6,000, while the securitized loan balance was $885,000. An estimate of the property’s value is in the range of $550,000.
The property was sold to an investor, SFR Investments Pool 1 LLC, for just the $6,000 balance of the HOA lien.
Morningstar called the ruling “troubling” for residential lending and noted that both agency loans and private-label securitizations are potentially impacted.
The report indicated that in Nevada, lenders do not need to be notified of an impending HOA foreclosure unless they request notification.
But most servicers don’t routinely check for HOA membership and are often unaware of an HOA.
“Owner-occupied borrowers who are underwater or cash-strapped may stop making all payments on the property,” Morningstar said. “Typically, servicers will advance whatever cash is needed to maintain the properties. However, if the servicers do not know about an HOA, the investors in residential mortgage-backed securities may take the hit.”
Mortgage-backed securities investors in such cases potentially face a complete collateral loss even though such risk was not factored into their original investments.
Morningstar said that the ruling could spark a wave of investors buying HOA liens in order to initiate foreclosure and take advantage of exposed lenders.
Morningstar noted that while there are 22 jurisdictions that allow super-lien status for HOAs, only Nevada and Washington, D.C., have allowed HOAs to extinguish first mortgages.
“HOA super liens are of growing concern to all participants, stakeholders and investors of the single-family residential lending market,” the report concluded. “In Morningstar’s view, investors in owner-occupied RMBS securitizations face the greatest potential risk.”
