Ins and outs of title insurance

There's another kind of insurance you buy when you buy a house or refinance: title insurance. It's an unusual kind of policy because it protects against something that might have happened in the past, rather than something that might happen in the future.

Title defects aren't common, but when they occur, the consequences can be disastrous.

Title insurance protects the lender or owner from disputes over ownership of property. When you buy real estate, someone checks land ownership records to find out if the seller has the right to sell it and collect the full payment.

Perhaps the seller is divorced and needs the ex-spouse to sign a document allowing the sale to go through. Or maybe an unpaid electrician put a mechanic's lien on the property, ensuring payment when the property is sold. The county might have filed a lien to satisfy unpaid taxes. And, of course, the mortgage lender has a lien on the property, ensuring that the loan is repaid before the sales proceeds go to anyone else.

One seller found out to his surprise that there was a "cloud" (title defect) affecting title to his property. The title search on his property showed that a deed had been recorded transferring title from the previous owner to himself. But that deed was signed by only one of the two owners.

Due to an oversight, the wife's signature wasn't on the deed. This meant that the wife could still make a claim to the property. In effect, she was still in title as an owner because she hadn't transferred her interest in the property.

A good title
Your real estate purchase contract should include a clause that requires the sellers to provide you with good or marketable title to the property at closing. If the sellers are unable to do this, you should be able to withdraw from the contract without penalty.

In the example above, the buyer's title insurance company was able to track down the wife's heirs and get the signatures necessary to remove the cloud on the title. The defect in the title report was corrected and the sale went through.

Most buyers take out a mortgage when they purchase a home. But before a lender will issue a mortgage, there will need to be evidence that the buyers will receive good title to the property. Also, the lender will require that a title insurance policy be purchased, usually at the buyer's expense, guaranteeing the lender's interest in the property.

Title insurance is paid for on a one-time-only basis. It is not transferable from one party to another.

Tip for first-timers
A lender's policy of title insurance won't protect the buyers' interest, but buyers can get title insurance for their own protection. Even if you're paying all cash for a property, and won't need a mortgage, it's wise to obtain a title insurance policy to protect yourself. Title insurance for the buyer can be paid for by either the buyer or seller. Who pays is often determined by local custom. The cost is based on the purchase price: the higher the price, the higher the title insurance premium.

Searching the records
Before issuing a policy of title insurance, title examiners search the public records for records that affect the property in question: such as liens, judgments and easements. An easement grants the right to use another person's property for a specific purpose.

The title search is designed to dig up all of these things and more. Later, if there is a dispute and a lawsuit over ownership of the property because the title search was faulty, the title insurer pays legal fees and any settlement amount. When you pay for title insurance, you're paying for two things: the title search and the insurance policy that pays the costs of future legal proceedings.

There are two kinds of title policies when you buy a house. One covers the lender (you have to pay) and the other covers you, the buyer. You'll always be required to get the former, and it's often a good idea to buy the latter.

Make sure you understand the kind of title insurance you're buying, for there are several kinds available. If you have a question about anything in your title search, ask your title insurer or attorney for an explanation before you close.