Title insurance: What it is and who it's for

There's a seemingly endless number of insurance products out there to help people and businesses protect themselves from all sorts of financial loss. We are most familiar with insurance policies like those for health care, valuable property or even the chance of unexpected death. But title insurance is one product that many people are less knowledgeable about, for a variety of reasons. It's a good idea for those of us who own a home or who are about to close on a first home, as well as most business owners, to get familiar with the ins and outs of title insurance.

What is title insurance?

In a nutshell, title insurance helps protect people and organizations from financial loss resulting from defects or oversights in the title of a piece of property. The vast majority of title insurance policies are written to cover losses related to land and homeowner contract issues, hence their relevance to people who own a home or business. The contracts related to other high-value assets, like a person's estate, might also utilize title insurance.

The Consumer Financial Protection Bureau wrote a brief overview of how title insurance comes into play during real estate transactions:

  • Anyone who buys a home must receive a deed from the seller - a document that proves the legal transfer of ownership from one party to another. The document that proves ownership itself is the title.
  • However, this legal transfer of ownership applies to more than just physical property - it also transfers responsibility for legal claims related to the title. If a home's previous owner did not pay property taxes, for example, the responsibility to pay them could fall to the new owner.
  • Title insurance policies provide financial and legal protection from these title "defects," both for the new homeowner and their mortgage lender, if applicable.

The losses stemming from claims against a home's title can be enormous, which explains why mortgage lenders usually require buyers to purchase title insurance before agreeing to move forward with a home loan. But, as previously mentioned, title insurance does not work quite like any other insurance policy you are probably familiar with.

Homebuyers are typically required to purchase title insurance as part of the escrow phase of their real estate deal. At this point, the buyer and seller are in general agreement about the terms of the deal, but need to work out any lingering issues before officially writing the deed and transferring ownership.

What title insurance protects against

Where title insurance separates itself is in the process: New owners pay a one-time fee for a policy, unlike conventional insurance based on recurring premium payments. The title insurance company then conducts research into the legal history of the title, generally by searching local public records. During this process, researchers are combing through records dating back many years, looking for any of several red flags including:

  • Liens, or claims of unpaid debts from creditors.
  • Illegal deeds used in prior sales.
  • Inconsistencies in prior title transfers due to inheritance, for example if heirs were missing or unknown at the time of the previous owner's death.
  • Forged documents related to the title or deed.
  • Undiscovered encumbrances, or prior claims against title ownership that may not be entirely financial.
  • Unknown easements or boundary disputes that could prevent lawful use of the home and surrounding property.
  • Simple errors made in the required documents that must be corrected.

Believe it or not, this is just a partial list of the many complications that buyers could run into when attempting to complete a home purchase. But with title insurance, these problems can be found and hopefully corrected before the responsibility falls to the new owner.

TitleTitle insurance affords some protection against a defective home title.

Lender's vs. owner's title insurance

Despite the legal complexity of title insurance, and even though buyers have the right to choose any policy provider they wish, the whole process is generally very standard and routine. Still, it helps to know exactly how you are being protecting when you buy a title insurance policy.

If you purchase a lender's title insurance policy per your lender's requirements, you gain some degree of financial protection for as long as you are paying off the loan. Should something happen in the meantime that results in the loss of your home, like a lien that was not discovered in title research, you can expect the rest of your mortgage to be paid off. However, lender's title insurance will not return your down payment or any equity you have accumulated in the home. And, most critically, you will be forced to leave.

That's why some recommend buyers purchase the required lender's title insurance policy as well as an owner's policy. Although these cost more money, they can provide a nearly comprehensive level of protection from loss due to title defect. With valid owner's and lender's title policies, you could recover the purchase price of your home as well as remaining mortgage debt, should a judgment against you arise.

Insurance products and services are not FDIC insured, not insured by any federal government agency, not a deposit or bank obligation, not financial institution guaranteed, subject to risk, including potential principal loss.

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