A successful real estate investor recalled his first purchase when he asked his Realtor: “Title Insurance – Do I need it?”
His Realtor replied: “You need title insurance to make sure nobody else owns the property you’re buying”. Source
The investor thought: “Huh? Who will sell me a building he doesn’t own? How can that happen?”
Over time, after hearing explanations of title insurance from various real estate professionals, the investor remained confused. That’s bad because while a home buyer only buys once or twice in a lifetime an investor makes many purchases.
Regardless whether you only buy one home or many homes knowing what title insurance does to protect you becomes important.
So, what is Title Insurance?
Using the purchase of a car instead of real property illustrates the need better. You see a nice looking used car on the street with a “For Sale” sign. You knock on the front door and a woman answers the knock.
Telling her: “Hello, I like the car parked in front of your house. Is it yours?”
She answers, “No, I don’t know who owns the car, but I’ll sell it to you for $25,000”.
You should see the problem here.
If you paid her $25,000 you won’t end up owning the car because she doesn’t own it.
Paying money to a stranger doesn’t mean you bought something. Without proof of clear title from the real owner of the car, you don’t become the new owner.
Since people can’t sell anything they don’t legally own home buyers and investors must protect themselves.
Look at title insurance as a safeguard protecting real estate buyers. Many issues affect the title to real property. Title insurance gives buyers assurances that their purchases occur with the actual owner.
You buy a $250,000 home and get title insurance for $250,000. Once you pay the seller and later find out that he or she didn’t own the home, your title insurance policy pays you the $250,000 you paid.
Title Insurance Protects You from False Sellers
A title search through public records establishes a clear “Chain of Title”. This means the title professional locates a clear record of all the previous property owners with links between them. A publicly recorded title deed shows a previous owner selling to a new owner. Then the new owner passes title to another new owner with a recorded deed.
A clear chain of title shows how each prior owner passed title to the next owner and so forth. It also shows when the title transferred from one owner to the next how much the new owner paid for the property. In addition, if any liens existed (like unpaid utilities, taxes, loans, civil court judgments, etc.) fully paid before title transferred.
Most often, a title search goes back several decades to locate a clear chain of title. Resolve issues like unpaid property taxes before title transfers to the new owner.
Title Insurance Protects You from Title Defects
Title defects include many things affecting the free transfer of title, such as:
- Outstanding mortgage not paid off;
- Prior deed contains a misprint of the owner’s name or an incomplete legal description;
- Unpaid property taxes with the county or city;
- The owner’s marital divorce settlement not paid;
- An unpaid subcontractor who performed work on the property;
- A pending lawsuit challenging the true property’s ownership; or
- No legal documents support the seller’s claim the he “inherited” the property with a legal right to sell it.
Often these defects arise because the seller purchased without conducting a title search. Thus, the seller owned the property for years without knowing the title defect existed.
Ordering a title commitment before the closing identifies the defects before you take title when they become your problem. The seller must fix the defects before title transfers to you.
Besides buying real property from a scammer, title insurance provides extra protection.
Even when buying from the true property owner other issues arise about the property that the seller may not know about. Such as:
Title Insurance Guards You from Breaks in the Chain of Title
When searching the title sometimes the searcher discovers a “break in the chain of title”. This occurs when the title skips one owner to another without showing all previous owners (via death certificates, deeds, divorces, foreclosures, etc.).
For instance, four prior owners of the property existed over the past 90 years. The title search must identify all of them and how title transferred in the correct order:
- Seller 1 sold to seller 2 in 1930;
- Seller 2 sold to seller 3 in 1950;
- Seller 3 sold to seller 4 in 2000; and
- Seller 4 is selling to you in 2019.
Any break in these chains of title creates a big problem. If no records exist of Seller 2 selling to seller 3 in 1950 then the later sellers all had a problem. That means you can’t own the property from seller 4.
How Title Insurance Saves You
When the title searcher completes the search the professional issues a title report showing “exceptions” to the title commitment. In other words, the title insurance company ensures you clear title to the property excluding the exceptions.
Don’t expect a title insurance company to issue you a policy including the exceptions. Like a “prior medical condition” exception to a health insurance policy. Your new insurance policy won’t pay for medical expenses resulting from the prior medical condition.
The title search actually saves you from buying the property with defects which you must clear up without title insurance coverage. Instead of closing on your purchase you demand the seller to clear up the title defects or you won’t complete the purchase. Better to walk away from the purchase if the seller refuses. Thank the title insurance company for discovering the defects which save you a lot of money and headaches.
If the seller resolves all the title defects the title insurance company issues the coverage allowing you to complete the purchase.
Most title defects are curable like:
- Unpaid mortgage? Maybe already paid off but the mortgage company forgot to discharge the loan.
- Subcontractor not paid? The seller pays them off.
- Inherited property missing paperwork? Contact the estate attorney to locate the missing documents and record them.
- Marital divorce settlement not paid? Ask the seller to pay it.
- Unpaid property taxes? The seller pays them off at closing.
- Pending lawsuit? The seller settles the lawsuit before closing.
How Title Insurance Protects You in the Future
Mistakes occur. For example, if the title search misses a defect and fails to list it as an “exception” the title insurance company must pay it (or clear it) when you sell the property later.
Buy Extra Title Insurance Owners Coverage
Tip: Purchase your title insurance policy for the full purchase price.
Lenders require real property buyers to purchase title insurance up to the mortgage loan. For instance, your $250,000 home contains a $150,000 mortgage loan. The lender only requires a $150,000 policy to cover the lender. It’s called a “lender’s policy”.
You need to purchase title insurance for the extra $100,000 equity, known as the “owner’s title insurance policy”. While not required by federal or California state laws, buyers should consider buying an owner’s policy for further protection at a low cost.
“Title Insurance – Do I need it?”
Yes, because it protects you from defects and cloud of title problems. While your lender requires you to buy a lender’s policy to protect the loan amount, you should consider getting an owner’s policy to protect your equity.
Don’t Forget about Escrow Services
Besides title insurance, using a professional escrow service protects you from problems during the closing process.
Steven Rich, MBA – Guest Blogger
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