Title insurance protects lenders and borrowers against any financial loss that might occur due to title defects. This type of insurance is important as it covers the claims on a property that might not appear during appraisal.
In real estate, title insurance holds great importance, and mortgage lenders and borrowers must be aware of it to prevent losses. Being a real estate student, you must fully understand how title insurance works. I’m a real estate professional, and I help real estate students, especially those who struggle with complex real estate terms.
After reading this post, you’ll learn the most accurate definition of title insurance. I’ll explain the concept in detail so that you clearly understand it.
What Is Title Insurance?
Title insurance is a type of insurance that protects home buyers and mortgage lenders from title defects. It is a one-time fee that the buyer has to pay when they purchase a property.
A title defect or claim can arise anytime due to legal issues. Even if the buyer has owned the home for many years without any problems. For instance, if there is an overlooked heir or someone else with ownership rights. Title insurance protects from such claims when they arise.
Home buyers and lenders can suffer from major financial losses due to third-party claims or defects in the property. Thus, mortgage lenders require home buyers to purchase title insurance before offering funds for buying a house.
Real estate transactions can have legal issues and claim to the title, which must be covered before the property is sold or transferred legally. An underwriter and appraiser evaluate the property by doing a title search. The title search helps determine such claims before the lender mortgage to purchase the property. However, even the most experienced and skilled professionals aren’t able to detect all defects in the property. Some title defects are challenging to identify, so title insurance is essential.
Title Defect
A title defect is a problem with the property that impairs the homeowner’s rights to the property. Title defects can be in different forms. For instance, a defective title may have a lien, judgment, existing mortgage, or a type of encumbrance. Since the third parties can claim the title on the property or the asset, the property can’t be sold or legally transferred.
In such cases, title insurance is really helpful in protecting the rights of lenders and homebuyers against title defects. A defective title in real estate is considered unmarketable, and all the defects must be cleared before selling the property. Some of the common title defects are as follows:
Liens
If the previous property owners were not responsible, there might be liens to the borrower’s property. For instance, if the previous owner hasn’t paid the mortgage or paid bills, their lender and other financing companies can put liens on the property. These liens are because of the unpaid debts and bills on the property. The liens must be cleared before selling the property.
Encumbrances
An encumbrance is a claim against a property by a third party. When a borrower purchases a property, there might be undiscovered encumbrances against it. The borrower might not know if a third party has a claim on a part or all of your property.
Mortgages
When a borrower takes a mortgage from a lender, the property title is transferred to the lender. The title remains in the lender’s name until the mortgage is repaid fully. However, when the mortgage is not paid in full, the homeowner can’t sell it to anyone. If the seller tries to sell the property, the lender’s right over the property will supersede the seller’s rights.
Easements
An unknown easement on the borrower’s property can prevent them from owning it fully. Easements are mostly non-financial issues, but they can still prevent borrowers from enjoying their rights altogether. An easement can allow a third party, like a business or a government agency, to access a part of your property.
Judgments
An unsatisfied judgment on the property can affect the borrower’s ownership. These unsatisfied judgments may be from the previous owner or the property seller. A judgment is a court order on the property, so the debtor pays it to a creditor.
Types of Title Insurance
The borrower’s closing costs may include title insurance costs. There are two main types of title insurance:
Owner’s Title Insurance
Owner’s title insurance protects the homebuyer from a financial loss if a title defect arises. This type of title insurance protects the home buyer’s rights as long as they have an interest in the property. The cost of owner’s title insurance is usually included in the home’s purchase price.
The coverage amount for the owner’s policy is equal to the property purchase price. This coverage remains constant throughout the time the homebuyer owns the property. This type of insurance is optional and can be purchased only once.
However, it is very beneficial for real estate owners. Home Buyers pay down the mortgage and as they keep on paying, they gain more equity in the home. This means that they can also lose more if a title defect arises in the future.
Lender’s Title Insurance
Lender’s title insurance is also known as lender’s policy. It protects the lender from the title defects that arise in the property. Before offering funds to the homebuyer for purchasing a property, the lender will require the homebuyer to purchase the lender’s title insurance. This type of insurance is helpful for the lender in case of financial losses if there is a title dispute.
For instance, Freddie Mac and Fannie Mae, are two organizations that have certain requirements for the lender’s policy. These organizations buy mortgages from qualified lenders after closing, and they require the lenders to purchase a lender’s policy. According to these organizations, the lender’s title insurance must be equal to or more than the mortgage principal.
Title Insurance Examples
A homebuyer, Tom, decided to purchase an old property of 20 acres. Tom applied for a mortgage to purchase the property, and the mortgage lender asked him to conduct a title search. So, Tom asked his attorney to conduct a title search for 30 years.
The title search didn’t discover any defects in the title, and the mortgage lender asked Tom to buy title insurance. Thus, Tom purchases lender’s title insurance and owner’s title insurance to protect their rights in case of a defective title.
A few years later, it was discovered that the property had been sold 50 years ago. Only one owner had signed the deed to sell the property at that time. The owner did not disclose this at the time of selling the property. The other owner was her husband, who died without signing the deed. Thus, the title had a defect. Therefore, it was necessary to clear the defect. To clear the defect, the attorney had to find the previous owner’s spouse’s obituary and locate his death certificate. Then he had to file it with the court.
Frequently Asked Questions
What Does Title Insurance Cover?
Title insurance covers all the problems with a property that have been unsettled. Before a borrower purchases a property, there can be issues associated with its title. The following are some of the title issues that the title insurance cover:
• Boundary disputes
• Property survey errors
• Conflicting wills
• Claims by previous owners
• Encroachments
• Liens from third-parties
• Illegal deed or errors in the deed
• Building code violations
• Forged documents
• Wrongly recorded documents
Is Title Insurance Necessary?
For purchasing a property, it is necessary to purchase title insurance for the lender. Most lenders will require the borrower to purchase a lender’s title insurance before they offer a mortgage. Though owner’s title insurance is optional, the homebuyer can purchase it to protect their rights.
Title insurance is included in closing costs, and it’s a one-time premium that mostly the homebuyer pays once escrow is completed. Without title insurance, the lender and the homebuyer are not protected from any defects in the title. A defective title can result in financial losses for both parties.
Who Pays for Title Insurance?
Generally, title insurance is paid by the homebuyer. However, the state laws and regulations for the payment of title insurance vary. In most cases, the homebuyer pays for it as they take funds from the mortgage lender.
Sometimes, the seller can also pay the title insurance fee if they want to sell the property. In some cases, the cost of title insurance is also split between the buyer and the seller. The buyer can pay for the owner’s title insurance, and the seller can pay for the lender’s title insurance.
How to Buy Title Insurance?
A loan originator or escrow agent helps buy title insurance once the lender approves the mortgage. At closing, the homebuyer can purchase title insurance by paying a one-time fee to the insurance provider. T
he cost of title insurance can be between $500 and $4000, depending on the property type and the insurance provider. The homebuyer can choose an insurance provider too.
What to Know for the Real Estate Exam
Title insurance is a protection for lenders and real estate owners against any financial loss to the property. Financial loss can result from title defects, including liens, mortgages, judgments, and encumbrances. Most homebuyers just ask their attorney or underwriter to conduct a title search to see if there are any title defects. However, a title search is often not enough, and title insurance is needed for additional protection.
As a real estate student, you must know the importance of title insurance in real estate. If there is no title insurance in place, real estate owners will be forced to pay all the claim costs on their property.
I hope you understand why title insurance is essential in real estate transactions. If you want to learn more such terms, go through this Real Estate Vocabulary.
