What Is Title Insurance?
Title insurance is a form of indemnity insurance that protects the holder from financial loss sustained from defects in a title to a property. The most common type of title insurance is lender's title insurance, in which the borrower purchases coverage only to protect the lender. Owner's title insurance is often paid for by the seller to protect the buyer's equity in the property and is available separately.
How Title Insurance Works
A clear title is necessary in any real estate transaction. Title companies must do a search on every title in order to check for claims or liens of any kind against them before they can be issued. A title search is an examination of public records to determine and confirm a property's legal ownership, and find out what claims are on the property. Erroneous surveys and unresolved building code violations are two examples of blemishes that can make a title "dirty." Title insurance protects both real estate owners and lenders against loss or damage occurring from liens, encumbrances, or defects in the title or actual ownership of a property. Unlike traditional insurance, which protects against future events, title insurance protects against claims for past occurrences.
A basic owner's basic title insurance policy typically covers the following hazards:
- Ownership by another party.
- Incorrect signatures on documents, as well as forgery and fraud or title documents.
- Defective recordation (flawed records or record-keeping).
- Restrictive covenants (terms that reduce value or enjoyment), such as unrecorded easements.
- Encumbrances or judgments against property, such as outstanding lawsuits or liens.
In lieu of title insurance, some private transactions can involve a warranty of title, which is a guarantee by a seller to a buyer that the seller has the right to transfer ownership and no one else has rights to the property.
- Title insurance is a form of indemnity insurance that protects the holder from financial loss sustained from defects in a title to a property.
- The most common claims filed against a title are back taxes that had been missed by a title company, liens (from mortgage loans, home equity lines of credit, easements), and conflicting wills)
- A one-time fee paid for title insurance covers pricey administrative fees for deep searches of title data that could go back to the early 1800s.
Purchasing Title Insurance
An escrow or closing agent initiates the insurance process upon completion of the property purchase agreement. There are five major U.S. title insurance underwriters, of which the agent or attorney typically recommends one. They are:
- Fidelity National Financial
- First American Corp.
- Old Republic National Title Insurance Co.
- Stewart Title Guaranty Co.
- Various regional independent companies
Owner's title insurance usually costs about 1% of the purchase price of the property, though this can vary from state to state. For example, the owner's title insurance for a $500,000 property in California should cost between $1,200 and $2,000.
Types of Title Insurance
There are two types of title insurance: lenders' insurance and owners' insurance (including extended policies). Almost all lenders require the borrower to purchase a lender's title insurance policy to protect the lender in the event the seller was not legally able to transfer the title of ownership rights. A lender's policy only protects the lender against loss. An issued policy signifies the completion of a title search, offering some assurance to the buyer.
Since title searches are not infallible (some short searches in residential transactions go back just a single deed) and the owner remains at risk of loss, there is a need for additional protection in the form of an owner's title insurance policy. Owner's title insurance, often purchased by the seller to protect the buyer against defects in the title, is optional.
The most common type of title insurance is a basic lender’s policy, which is purchased by banks and other financial institutions to cover mechanics’ liens and other unrecorded liens, unrecorded easements/access rights, and defects/other unrecorded documents.
Often, a lender's policy and an owner's policy are required together to guarantee everyone is adequately protected. At closing, the parties purchase title insurance for a one-time fee. To prevent abuse, the Real Estate Settlement Procedures Act (RESPA) prohibits sellers from requiring purchase from a specific title insurance carrier.
Risks of Not Having Title Insurance
Having no title insurance exposes transacting parties to significant risk in the event a title defect is present. Consider a home buyer searching for the house of their dreams only to find, after closing, unpaid property taxes from the prior owner. Without title insurance, the financial burden of this claim for back taxes rests solely with the buyer. They will either pay the outstanding property taxes or risk losing the home to the taxing entity. Under the same scenario with title insurance, the coverage protects the buyer for as long as they own or have interest in the property.
Similarly, lenders title insurance covers banks and other mortgage lenders from unrecorded liens, unrecorded access rights, and other defects. In case of a borrower's default, if there are any issues with the property's title, a lender would be covered up to the amount of the mortgage.
Real estate investors should make sure that a property does not have a bad title before proceeding with any purchase. Homes in foreclosure, for example, may have a number of outstanding issues. Buyers may consider purchasing owner’s title insurance to protect themselves against unforeseen claims against the title.