Why You Need Title Insurance
When a person buys a car, the seller transfers the car’s state-issued title to the buyer. The buyer’s name on a car’s title establishes the proof of ownership.
The title to a home is more complicated than a car’s title. Titles for real estate are not one-page car titles like we see issued by our state. Instead, real estate titles are file folders containing an array of documents that include:
- Names of past owners
- Easement rights held by utilities and neighboring properties
- Covenants, conditions and restrictions on the property’s use
- Rules for the local homeowner’s association, if there is one
- Any liens on the property, including:
- Liens for unpaid IRS or property taxes
- Mechanics liens for unpaid work completed by contractors
- Judgment liens filed against the property owner
- Claims by other people who claim an ownership interest in the property
- Deeds that conveyed interest in property from one owner to the next
The last item, the deed is one of the most misunderstood. A deed is a formal legal document that transfers the bundle of rights we call property ownership from the old owner to the new owner. A deed is not a title, and a title is not a deed, but a deed becomes part of the chain of title and is included in the file folder with a property’s other legal documents.
Local county recorders are the keepers of property titles. County recorders are responsible for filing title documents for each parcel of land in proper order. However, because county recorders are staffed by people who handle hundreds of documents daily and people make mistakes, it is possible for liens, judgments, and other claims to be misfiled. Therefore, it is possible for old liens and mortgages to appear after the new buyer takes possession of a property he or she thought had a clear title.
Also, it is possible for relatives of the former owner to make ownership claims after the close of escrow. For example, the seller may have filed a forged deed that conveyed the property from a spouse who was separated from the seller. Or, the seller may have previously sold the property to another buyer that the seller knew neglected to file the deed with the county recorder. These examples may seem far-fetched, but they happen with enough frequency that most lenders require a buyer to obtain title insurance.
What Title Insurance Is…
Title insurance is a one-time payment to a title insurance company. The cost is based on the balance of the loan or home’s price, add-ons that are available in some states, and the rates allowed by your state or local market. You will want to make sure the policy protecting you covers the full value of your property. If your lender requires you to purchase title insurance that protects it, which most commercial lenders do, make sure the value of the policy reflects the value of the amount borrowed only.
What Title Insurance Is Not…
Title insurance does not guarantee the property has a clear title. Title insurance is not a replacement for a title search. A title search is a physical examination of the county recorder’s files to see if any surprises, which were discussed above, lurk in the title’s file folder. However, even the most competent title search will not a prevent all of the potential maladies that can befall a title.
Title insurance will not replace a homeowner’s fire insurance, nor will it step in should the borrower default on the loan payments.
Title Insurance & Other Insurance Home Buyers May See at Closing
The close of escrow can be overwhelming to home buyers due to volume of information the lender, title company, and your attorney (if required in your state) present to you. You will be presented with disclosures, and required to show proof of homeowner’s insurance. You may be required to buy title insurance, private mortgage insurance, or if your loan is guaranteed by the FHA, mortgage insurance premium. The title company or your lender may offer you a life insurance plan that pays the balance of your loan should you die. The table below compares and contrasts the separate types of insurance home loan lenders offer.
|Insurance Home Buyers May See At Closing|
|PMI & FHA MIP||Mortgage Life Insurance||Title Insurance|
|Purpose||Reimburse lender if buyer defaults.||Pays-off home loan if borrower dies. Optional.||Protects homeowner or lender from claims on title|
|Cost|| FHA MIP: 1.5% up-front fee at closing, then premium of 1.1% to 1.15% of the loan amount / year. |
PMI: .5% divided over 12 months
|Varies depending on size of loan, age and health condition of insured.||Varies from $1.50 to $3.80 per $1,000 in value. Some states fix the rate, others allow price competition.|
|Benefit||Lender knows it will be reimbursed if buyer defaults, thus making loans available to low-downpayment buyers||Insurance company pays balance of loan, or in some policies, becomes permanently disabled and unable to work. Homeowner’s heirs inherit home free and clear of mortgage.||Covers defects in title and unexpected claims against the title, such as unknown heirs or owners claiming an interest in the property.|
|Beneficiary||Lender||Homeowner’s heirs||Homeowner or lender|
|Removal|| FHA MIP: mandatory for the first 5 years on 15+ year loans, and is removed when loan balance is < 80% home value. |
PMI: when loan balance reaches 78% of original appraised value.
|Cease paying for the policy.||Not applicable|
Title Insurance Buying Tips
Title insurance benefits the lender, or you and the lender. Check the fine print in your title insurance contract or ask your loan officer who the beneficiary is or beneficiaries are on your title insurance.
In some states, the prices for title insurance are set by state law, so shopping around is a futile exercise. In other states, title insurance is an open market, so shopping is worth your time. In New York, some counties have prices fixed by the state, and others (mostly upstate New York) are open market. See the Bills.com resource Title Insurance Rates to learn the rates in your state.
Federal law allows home buyers to choose the title company, so even if the rates are fixed you still can choose which company handles the transaction and provides the insurance.
If offered, some title insurance add-ons are a wise choice depending on your circumstances. The add-ons include incorrect surveys, violations of building permits or zoning laws, and adverse possession. Consider these add-ons when you are buying rural properties where it is possible the previous owner took short-cuts when putting up out-buildings, fences, or additions to the main house. Conversely, many add-ons are a waste of money in suburban tract homes that have little alteration.