What is it?
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 the lender's title insurance, in which the borrower purchases coverage only to protect the lender. The 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 for 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 to find out whether there are any claims are on the property. Erroneous surveys and unresolved building code violations are two examples of blemishes that can make the 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 concerning 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.
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 an interest in the property.
Similarly, the lender's 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 an owner’s title insurance to protect themselves against unforeseen claims against the title.