Imagine that you've bought a home: you're all moved in, enjoying the neighborhood and making the home "your own" by brushing on fresh paint and installing new carpet. Then, you get a letter from a lawyer stating that someone else claims to own the house, or that the previous owner used the house as collateral on a loan that hasn't been paid. Suddenly, you are in fear of losing your new home.
In a related scenario, a utility company might announce that it wants to access electrical, gas or phone lines that are located directly under a family room or kitchen addition to your house. You're looking at major, unanticipated repairs.
How do you protect yourself from such difficult and potentially costly situations? The answer is title insurance. This type of insurance (which your mortgage lender, if any, will insist that you buy) is designed to protect you against defects in title; that is, to protect your free and clear ownership of the land and your bank's ability to rely on it as valuable collateral.
Although title insurance policies and coverage vary by state and by insurance company, the process of getting a policy usually includes:
- the title company evaluating your house's history and chain of title and issuing a preliminary report before the closing, and
- the title company issuing a commitment to insure the house at closing.
In order for you to understand what title insurance is and how it works, you need to know a few things about the underwriting process and some terms connected with this type of insurance.
What Is Title Insurance?
For a home buyer's purposes, a title insurance policy is a contract in which the an insurance company ("insurer") agrees to "indemnify," or compensate, the "insured(s)" (you as the buyer, your lender, or better yet both), for financial losses sustained because of things like:
- mistakes or forgeries in wills, mortgages, or title documents relating to the property
- allegations that a past owner or co-owner did not consent to the conveyance, perhaps due to an undisclosed divorce, commission of fraud, or an error during the probate of an estate
- defects made in the required transfer or conveyance documents, or
- liens or encumbrances on the real property, for example based on past debts for taxes, contractor's work, or child support obligations.
Note that the insurance relates entirely to past, not future events.
The lender's portion of the policy protects it against situations where, for example, the mortgage is unenforceable against the borrower (you) because you do not in fact have legal title to the home, perhaps because the seller didn't own the land "sold" to you. In such a case, the title insurer might have to pay the bank for its loss on the mortgage.
More importantly if you are the home buyer, if after you buy the home a neighbor claims and proves that he had bought several feet of your property from your seller several years before the sale and recorded a deed, the title insurer would have to pay you for your loss if it failed to discover the sale.
Step One: The Preliminary Title Report Is Issued
Soon after the home buyer and seller sign a purchase contract and enter escrow, a title insurer (or "title company" or attorney) will perform a "title search," that is, it will investigate the public records in the government land office (or "recorder's office") in the county where the home is located. In this search, it's looking for documents that affect title to the land, such as deeds and liens.
The title company then issues a preliminary report. This lists and details the liens, easements, or other encumbrances on the land. These will be listed as "exceptions" to insurance coverage, that is, if the insurance policy was to be issued on the date of the preliminary report, the insurer would not pay you for any loss you were to sustain as a result of one of the listed items.
So, the preliminary report serves two purposes for the buyer: It gives you an idea of who has any type of interest in the property and it gives you and the seller a chance to have any clouds on title removed, if possible, before the sale. If, for example, the seller failed to pay property taxes and the government put a lien on the property, you'll want the seller to pay the tax lien before the closing.
A preliminary report does not give you any insurance coverage. It is simply an offer to give you insurance coverage, listing the various ownership interests in the land and what items will be excepted from coverage if you, as the home buyer, decide to accept it.
Step Two: The Title Company Issues a Commitment
A commitment is a time-delimited agreement by a title insurer to issue a title insurance policy to you to cover your home and land to sell you a title insurance policy for a specified price, or "premium."
Almost always, the commitment will contain conditions that have to be met in order for the insurance to go into and to remain in effect and exceptions to coverage, that is, as in the preliminary report, a list of items that will not be covered by the policy.
Examples of typical conditions include things like:
- payment of the seller's mortgage
- payment of all liens against the property and all taxes owed at the time of sale, and
- issuance of a valid deed transferring ownership to the buyer-insured,
Some exceptions that are commonly listed in title insurance policies include:
- restrictions, conditions, and covenants (CC&Rs) that were revealed in the public records. CC&Rs are common in new subdivisions and typically restrict uses of the land, such as what color the owner can paint the house and how many cars the owner can park in the driveway, and
- any claims, liens, and encumbrances against the property that were not part of the public records at the time of the title search.
Get an Owner's Title Insurance Policy
In almost all cases where a buyer takes a mortgage, the bank or lender requires the buyer to pay for a mortgagee's or lender's title insurance policy that protects the bank against title defects. This policy does not cover you in any way. So, be certain to also buy an owner's policy to protect yourself.
Questions for Your Attorney
- How long will it take to get a title insurance policy and how much will it cost?
- Can I shop around for title insurance?
- Can I buy the seller's old insurance policy, and if so, is it a good idea to do so?
- Is the seller's old insurance policy cancelled automatically once I buy and take possession of the house?
- A title company gave me a commitment, but it won't answer my calls or letters about actually giving me a policy. What can I do?
- What happens if my title insurance company goes out of business?