Before we go on about what title insurance is, we need to be clear about what a title is. According to stewart.com, the title to a piece of property is the evidence that the owner is in lawful possession of that property. In simpler terms, a title legally proves that the property belongs to the owner.
So now, what is title insurance? Title insurance protects real estate owners and lenders against any property loss or damage they might experience if any issues arise regarding the title to the property. Each title insurance policy is also subject to specific terms, conditions, and exclusions.
Types of Title Insurance
There are two types of title insurance — the lender’s title insurance and the owner’s title insurance. The more common one of the two is the lender’s insurance, which the borrower purchases to protect the lender. The second type is often paid for by the seller to protect the buyer’s equity in the property.
Almost all lenders require the borrower to purchase a lender's title insurance policy to protect the lender if the seller is legally unable to transfer the title of ownership rights. A lender's insurance policy only protects the lender against loss, not the borrower.
Because title searches are not foolproof, and the owner remains at risk of financial loss, the second type of title insurance exists. The owner’s title insurance is often purchased by the seller to protect the buyer against defects in the title, but this type of title insurance is optional.
Title insurance protects against claims from defects. Defects are things such as another person claiming an ownership interest, improperly recorded documents, fraud, forgery, liens, encroachments, easements, and other items specified in the insurance policy.
How It Works
For any real estate transaction, having a clear title is necessary. Title companies do a search on every title to check for claims or liens of any kind against them before they can be issued.
A title search is done to determine whether anything has been claimed against a title before it is issued. This is done to ensure that the owner or lender is safe from financial loss due to a bad title. Common claims filed against a title are back taxes, liens (from mortgage loans, home equity lines of credit (HELOC), and conflicting wills.
A basic owner's title insurance policy typically covers the following hazards:
- Ownership by another party
- Incorrect signatures on documents, as well as forgery and fraud
- Flawed records
- Restrictive covenants (terms that reduce value), such as unrecorded easements
- Encumbrances or judgments against property, such as outstanding lawsuits and liens
Unlike traditional insurance, which protects against future events and is paid for with monthly or annual premiums, title insurance protects against events in the past of the real estate property and the people who owned it for a one-time premium paid at the close of the escrow.
Risks Of Not Having One
Having no title insurance exposes transacting parties to significant risk if a title defect turns out to be present. Consider a situation where the homebuyer who has finally bought their dream home finds out that the prior owner left them with unpaid property taxes after closing. Without an owner’s title insurance, the amount of back taxes will be paid solely by the buyer. The homebuyer will need to pay the outstanding property taxes or risk losing their new home to the taxing entity.
On the other hand, if the homebuyer had title insurance, the policy would protect the buyer as long as they own or show interest in the property.
Real estate investors and homebuyers should ensure that a property does not have a bad title before proceeding with any purchase. In particular, homes in foreclosure may have several outstanding issues. Buyers may consider purchasing an owner’s title insurance policy to protect themselves against unexpected claims against the title.
A real estate purchase may be the largest financial investment you will ever make, which is why it’s essential to do everything right. When you consider buying a title insurance policy, simply think of it as buying some peace of mind! Even though you'll pay for the title insurance only once, your coverage will last as long as you own your home.
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