What is title insurance and why do i need it

Getting title insurance is one of the standard steps homebuyers take before closing on a home purchase. Title insurance is crucial for a homebuyer because it protects both you and your lender from the possibility that your seller doesn't—or previous sellers didn't—have free and clear ownership of the house and property and, therefore, can't rightfully transfer full ownership to you. Even though the chance of actually making a claim for coverage is relatively low, the value on what you stand to lose if you go without coverage is high—you could, in fact, lose the house itself.

Read on to learn how title insurance works, how and why you could lose your home without title insurance, and how title insurance helps protect you.

How to Get Title Insurance

Your escrow or closing agent will launch the process of getting you title insurance soon after your purchase agreement is signed. Usually your closing agent or attorney will choose your title insurer for you.

You will probably need to shell out a one-time fee of around $1,000 for title insurance. (In some states or locales, however, the seller traditionally foots the bill.) The process is all very standard and likely to go through without a hitch.

What Could Happen If You Don't Get Title Insurance?

Here's how things could go wrong. At the most extreme, the sellers might knowingly try to sell you a home they don't own. There have been instances of renters posing as sellers. However, typical title issues are less worthy of a crime show, but more complicated.

For example, the seller might have copurchased the house ten years ago with a brother he hasn't talked to since—and he's unaware that he now needs his brother's signature to sell. Or sometimes, problems lurk in the more distant past. For example, the seller might have bought the place from a single woman, not realizing that her ex-husband still co-owned the property and hadn't signed off on the sale as required. Or the seller might have inherited the house under the terms of a will that—oops—turns out to have been out-of-date, and a more recent will leaves the house to someone else.

Not all title problems involve the whole house. For example, people or agencies might have filed liens against the property—legal claims to be paid from the proceeds of the property's sale, in order to settle the homeowner's debt to them. The most common types of property liens seek payment for debts related to taxes, child support, and contractor's fees (often referred to as "mechanics liens"). These liens stick to the house like glue, until the house is sold or foreclosed on. Disputes over property boundaries also often result in title insurance claims.

In any of these situations, title insurance will step in to help. One important note on co-op housing: If you're buying a co-op, where you won't actually own real estate (just shares in a corporation), no title insurance is needed.

Title Insurance: Lender's Policies and Buyer's Policies

Title insurance is typically a combination of two policies: a lender's policy and a borrower's policy. Your lender—assuming you're taking out a mortgage loan—will require that you buy a lender's policy (also called a "mortgagee's policy") to pay for its legal defense costs and reimburse any mortgage payments you can't make because you've lost the house to someone else's claim on it.

The lender might also require you to buy an "owner's policy" to cover your own legal fees and other losses, as yet another step toward protecting the lender's collateral. Even if your lender doesn't require you to buy an owner's policy, you should probably consider buying one anyway.

Why do you need both policies? No preliminary title search (see below to learn about title searches), no matter how complete, can predict when a long-lost relative or heir will turn up or whether paperwork buried for years under a misspelled name will reveal a claim concerning the property. The lender's policy will kick in to defend such claims and, if all goes well, might resolve the matter against whoever brought it up.

But what if the court decides that, for example, the long-lost relative is in fact the house's true owner? Then the lender's policy will reimburse the lender for what you owe on the mortgage—but you'll be out the amount of your down payment and other principal payments, not to mention that you'll no longer own the house. The owner's policy, however, will cover your financial losses (though you might still have to move out of the house).

How the Preliminary Title Report Helps Ensure Clear Title

No one wants the past to come back and bite the homebuyer this way, which is why the title insurance company will perform a "title search" as its first task before issuing the policy. (Or your attorney might handle this, depending on the custom in your state.)

The search involves combing through public records concerning the house—including past deeds, wills, trusts, divorce decrees, bankruptcy filings, court judgments, and tax records.

The resulting preliminary title report (sometimes called a "title insurance commitment," "commitment of title," or an "encumbrance report") gives everyone a chance to eliminate trouble spots before proceeding with the sale—or to call the sale off, if anything too serious is uncovered. It also lets everyone know the conditions under which you'll be offered insurance. For example, the policy won't cover some things that can't be known or cleared up (exclusions).

Fortunately, you shouldn't be the one who has to act on any title defects. Since you're being promised clear title, any clouds that emerge are the seller's problem, not yours. The closing agent will normally call the seller's real estate agent or attorney if the report shows a defect. Most sellers agree to pay off any liens through a deduction from the purchase money at closing.

For more information on purchasing title insurance and other legal and practical tasks involved in buying a house, see Nolo's Essential Guide to Buying Your First Home, by Ilona Bray, Ann O'Connell, and Marcia Stewart (Nolo). If you ever end up in a situation where you might have to make a title insurance claim, consider consulting with a local real estate attorney to go over your options.

Title insurance: It’s another one of those mysterious fees buried inside the pile of paperwork you'll receive at your loan closing. Who knows what it's all about? All you've figured out is that lenders require a policy for their protection, and either you or the seller will have to pay for it — and then you’ll be asked if you want an owner’s title policy, too.

Here's how title insurance works, how to decide whether you need your own policy, and how much you can expect to pay.

Title insurance protects the insured from a financial loss related to the ownership of a property. There are two policies in the mix at a home loan closing: the lender’s policy, which is required, and an optional owner’s policy. Both are a one-time, upfront cost — not a monthly premium that will be added to your mortgage payment.

When you're in the process of buying a home, a title research company will check the property's ownership history. Ideally, your new home has what's called a “clear title.” That means the current owner, who is selling to you, has a complete ownership stake in the property, without any legal claims against it. Claims can be in the form of a lien or levy from a lender, creditor or — in the event of taxes due — the government.

If the research company doesn't find any outstanding claims or title defects, why buy title insurance? Because an as-yet-undiscovered issue could cloud the ownership of the property years after the purchase. That could be a mistake in the ownership history, an oversight committed by the title researcher, even a previously unknown heir. Maybe there's a pending lawsuit or legal judgment. A title issue could also arise as a matter of fraud.

A title defect that arises after a loan closing could, at the very least, mean a variety of legal costs — and, in a worst-case event, the loss of your property and the money you’ve put in it.

Lenders insist on title insurance to protect their interest in the loan. And that makes sense, because they're on the hook for the majority of the home's value, especially in the early years of the mortgage.

» MORE: Calculate your closing costs

Can you make a case against buying the owner’s title insurance policy? Sure. But let’s think this all the way through before making a decision.

“Here’s the deal: When you buy a house or build a property, usually you get a warranty deed,” says Martin Farris, a mortgage broker in San Angelo, Texas. “That means the seller is saying, 'This is a good deed. I own this property free and clear. I'm transferring it to you free of any other liens.’"

So any ownership defect would be the seller's responsibility, right? And as a buyer, you’re in the clear — any legal action would be against the seller. But remember, the seller has transferred that risk to the insurance company. And even though the lender is protected by the title policy, your stake in the home could be at risk. That would be equal to your down payment and any equity you have. Again, a title claim could happen many years after your purchase.

For many home buyers, purchasing an owner’s title insurance policy is a matter of being safe rather than sorry.

A lender’s title insurance policy is a given, and maybe now you think an owner’s policy isn't a bad idea. How much will it cost to buy both?

Sometimes nothing. You might be able to negotiate to have the seller pay for both policies.

But if you end up shouldering the cost, your policy might not cost much. "When you buy two title policies in Texas, the first one you buy at full price. The second one you buy and they charge you a hundred bucks for it," Farris says. It’s a discount called the “simultaneous issue rate" — kind of a “BOGO” thing.

Prices and discounts vary from state to state. You can expect to pay somewhere between $1,000 and $4,000 for title insurance, according to CourtHouseDirect.com, a courthouse data research website.

The American Land Title Association provides a list of insurers by state and city. There are also title insurance providers online, such as EntitleDirect.com.