What is Title Insurance Exactly?

If you are buying a new home you may find yourself reviewing the offer paperwork and coming across something called “title insurance.” While title insurance is pretty standard in most real estate transactions, it can be confusing for new homebuyers.

Here is a quick overview of exactly what title insurance is, and why you and your lender need it.

What is title insurance exactly?

Title insurance protects you and your lender from the possibility that the person selling you a home doesn’t have a free and clear title to the house, which means they cannot transfer full ownership to you.

If, after you purchase a home a person or institution (such as a bank or mortgage lender) steps forward and claims they have an ownership stake in the property, title insurance will cover any losses (yours or the banks) that arise out of the dispute.

While title insurance is rarely called on to make a claim, in fact only 4-5 percent of title insurance policyholders have actually been paid out, it can be a financial lifesaver. If the other person’s claim of ownership turns out to be valid, you could lose your home.

Here are just a few examples to make things a bit clearer:

• A less than honest renter of a home poses as the owner and sells the house they are renting. When the actual owner of the home discovers the sale, they will rightfully claim ownership of the property, leaving you out in the cold.
• Siblings or other family members buy a home together and a family dispute leads to them not talking for years. If one of the owners sells the house without notifying the co-owner, that co-owner would still have an ownership stake in the house and could make your life difficult.

Divorces can often result in ownership issues. If a divorced woman (or man) sells her home, it is possible that her ex-husband (or ex-wife) may still have an ownership stake in the home which could come back to haunt you

Do I have to Get Title Insurance?

The quick answer is yes, unless you are purchasing the home free and clear without a mortgage. If you are willing to take the risk and are paying all cash for a home, you are not required to purchase title insurance. It is important to remember though that if a title issue does come up, you will be on your own for both legal costs and the loss of your home if the claim is valid.

If you are taking out a mortgage to purchase your home, your lender will require title insurance. This protects their interest in the home until you have paid it off.

In most cases, the process is fairly standard. Your closing agent (whoever is handling the closing of the sale) will put you in touch with a title insurer (there are five major ones in U.S.) and they will start a title search.

Prices can vary but expect to pay around $1,000 for title insurance. This is a one-time fee and the policy protects you as long as you own the home. In some states the seller typically pays for title insurance but this does vary so check with your real estate agent about norms in your area.

Two Policies in One

In most cases, title insurance is a combination of two different policies. The “lenders policy” protects your mortgage lender and helps cover legal costs as well as reimbursement of mortgage payments you fail to make if you lose the house. This portion of title insurance is always required if you have a mortgage on the home.

The “owners policy” protects you and reimburses legal fees and other losses (down payment and mortgage payments) related to the title issue if someone comes forward to make a claim. While not all lenders require you purchase this portion of the policy, most experts highly recommend it.

Without a “owners policy”, if a long lost relative shows up claiming ownership of the house and the courts decide they are right, you will not only be moving out of your home but you will have lost your down-payment and all of the mortgage payments you have made since owning the home.

How the Process Works

Like most insurance products, the insurer will want to do some homework before issuing a policy. When it comes to title insurance this involves a detailed “title search.”

The title company will search through public records concerning the house. They will look at past deeds, trusts, wills, divorce papers, bankruptcy filings as well as tax records and any judgments related to the house.

They then issue a report called a preliminary title report, it can also be called a title insurance commitment or encumbrance report. This lets the buyer, seller, and mortgage lender know if there are any issues with the title so everyone is on the same page and can make a decision to proceed or stop the sale.

If there are issues with the title such as unpaid liens they will fall to the seller to clear up before the sale can proceed. In most cases, the seller will pay off any outstanding liens. If the title search uncovers more complicated issues you may need to pull out of the sale.

Once all title issues have been resolved (or even better there were none to begin with) a title insurance policy will be issued and you can proceed with the purchase of your new home.