What Is Title Insurance?
If you’re thinking about buying a house or if you’re in the middle of getting a mortgage, you may be wondering about all of these insurance policies. There’s homeowner’s insurance, private mortgage insurance (PMI), mortgage life insurance and sometimes earthquake or flood insurance.
But perhaps one of the least understood is title insurance.
What’s more, no one seems to talk much about it during the home-buying process. It’s mostly a line item that shows up on the Closing Disclosure and the Loan Estimate at application, and the HUD-1 Settlement Statement at closing.
In this guide, we’ll clear up all of your questions and misconceptions about this very important real estate related insurance policy.
What Is Title Insurance and Why Do You Need It?
Let’s start with the word “title,” which is a legal word used to describe real estate ownership. When you buy a home or other real estate, you hold title to the property.
In order to be able to sell or finance the property, you must have clear title to it. That means you must be able to deliver title (ownership) of the property to a buyer, or pledge it as collateral to a lender, free of any liens and encumbrances.
The reason this is necessary is because when it comes to real estate, the priority of a lien is established by when it was imposed. For example, if you apply for a refinance mortgage in 2018, but a lien was placed on your property in 2015, that lien will have priority over the mortgage in the event of a foreclosure action.
Mortgage lenders require that you are able to deliver clear title to the property as collateral for the new loan. That means all prior liens will need to be satisfied before you can close on the new mortgage.
The Title Search
Anytime you apply for financing on your home, the lender will require that a title search be performed. This will be a requirement whether the new loan is being used to purchase the property, refinance existing debt, or establish a home equity loan or home equity line of credit (HELOC) on the property.
The title search will look to confirm the following:
• The name or names of any and all legal owners of the property.
• That no outstanding liens or encumbrances exist on the property, other than properly recorded mortgage loans.
Legal ownership is critical to mortgage financing, since you must own a property in order to get a loan against that property – using the property as collateral.
Liens and encumbrances can include mechanics liens, court judgments, tax liens or privately held mortgages. These types of obligations typically show up on personal credit reports. However, it’s possible that a lien on the property was either not reported to the credit bureaus, or was the result of an unsatisfied obligation of a previous owner.
In that sense, we can think of a title search as something akin to a credit report on a piece of property.
The mortgage company will insist on the satisfaction of any outstanding liens and encumbrances. This ensures the new mortgage becomes the first lien on the property.
The title search will be performed by a title company, which executes a thorough search of real estate and court records in the jurisdiction where the property is located.
Once the title search determines proper ownership, and the absence of any liens and encumbrances, the mortgage process can go forward.
Why Do I Need Title Insurance If There Are No Liens on the Property?
Despite the fact that title companies do a thorough job of investigating both ownership and liens, information can still be missing.
Upon the completion of the title search, the title company gives the property a clean bill of health. But just in case any liens surface after the fact, title insurance is required.
The title insurance policy will cover a lien or encumbrance that’s discovered after the title search has been completed. It’s a rare event, but should one show up, the lender would automatically be in a second position behind the undiscovered lien.
In addition, you as the property owner would be unable to either sell or refinance the property because of your inability to deliver clear title.
The title insurance policy will pay the undiscovered obligation, clearing the title. That will enable the current mortgage holder to remain in the first lien position, and the property owner to be able to deliver clear title when necessary.
Unlike other types of insurance policies that require annual, quarterly or monthly payments, title insurance requires solely a one-time payment. The policy is issued just prior to closing, and the premium is collected at the closing table, as part of the total closing costs.
How Much Does Title Insurance Cost?
The cost of title insurance varies, based on the value of the property, the amount of the mortgage you are applying for, and your state of residence. Because of these three variables, the cost difference from one property to another can be substantial.
The premium can vary anywhere from around $200 up to several thousand dollars. However, in most cases you can expect to pay $400 to $1,000.
Much like life insurance, title insurance is calculated based on a per thousand basis. The rate can be applied against either the value of the property or the amount of the mortgage you’re applying for.
For example, a $300,000 loan taken on a $400,000 property in Los Angeles County, California, would require a premium of $954. Once again, this premium is paid only once, and not on an annual basis.
What’s important to remember is that title insurance is not a separate charge. It will be included in your closing costs, both when you apply for a mortgage, and at the closing table.
Who Pays for Title Insurance?
This is a tricky one, because well, it depends. The decision over who pays for title insurance is primarily driven by state and local custom, and even then can sometimes be negotiable between the buyer and seller. A great starting point is to check out this fee guide, which breaks down the fee customs by state.
How Often Is Title Insurance Used?
Title insurance will be required any time you either purchase a property, or take a loan against it.
Once again, the necessity is the ability to provide a clear title. A lender will insist on a clear title to ensure their loan will be in the first lien position.
If you sell the property, clear title is necessary to give proper legal ownership to the new owner.
What Does It Protect? What Does It Cover?
As noted earlier, title insurance is necessary to protect against undiscovered liens and encumbrances on a property, as of the date of the title search. Should any appear, they will be covered by the title insurance policy. That will guarantee clear title will continue despite the discovery of the lien or encumbrance after the fact.
There are two types of title insurance policies:
1. Lender’s title insurance, and
2. Owner’s title insurance.
Lender’s Title Insurance
Lender’s title insurance is required by the lender. It also names the lender as the insured party in the event of an undiscovered lien. That is, lender’s title insurance protects the lender by making sure the lender’s loan always remains in the first lien position.
Owner’s Title Insurance
Owner’s title insurance is strongly recommended because it guarantees the owner freedom of action, despite what’s happening with the lender’s title insurance policy. By having your own title insurance policy, your ownership in the property will be protected, even if a lien is discovered after the title search.
One of the big advantages with owner’s title insurance is that the premium is much cheaper than lender’s title insurance. For example, if the lender’s title insurance policy is $800, the owner’s policy may be only $300.
Just as is the case with lender’s title insurance, owner’s title insurance is a one-time premium payment. And it’s some of the best money you will spend in purchasing or refinancing your property.
Do I Still Need Title Insurance If I Pay Cash?
Since title insurance is a lender requirement, you may assume it’s unnecessary if you’re paying cash for the property, and not using a lender.
You may have that option, but you’re playing with fire if you go without it.
You’ll still need to get a title search performed when you purchase the property. But if any liens or encumbrances are discovered after the date of the search, you’ll have no title insurance coverage to satisfy them.
That means you’ll be on the hook to pay a lien or encumbrance of a previous owner.
If you’re purchasing a property in an all-cash transaction, you should get an owner’s title insurance policy. Any undiscovered liens or encumbrances will automatically be covered under that policy. That will leave you free to sell or refinance the property anytime you choose.
Be Especially Careful With For-Sale-by-Owner Purchases
This can be particularly important with for-sale-by-owner (FSBO) transactions. These tend to be less formal than those that are handled through a real estate agent. There may be a temptation to forego certain procedures in an attempt to save money.
But the same situation also applies to FSBO property purchases. Even if the people you’re purchasing the property from seem like the nicest people on the planet, there may still be an undiscovered lien or encumbrance hiding somewhere in the past. Taking an owner’s title insurance policy is your best protection against that outcome.
Ownership, or title, to real estate can be complex and confusing when buying or refinancing your home. Insurance in the midst of this complexity can be your best friend, and having a thorough understanding of title insurance makes you a better educated and protected home owner.