Title insurance optional? Not likely
By Holden Lewis • Bankrate.com

A U.S. senator says he knows how to promote homeownership: Make title insurance optional.

Sen. Phil Gramm's notion is unlikely to become reality. No responsible lender would want to lend money to a home buyer without the services that title companies provide, only one of which is an insurance policy.

Gramm, R-Texas, spoke up on Dec. 13 during an appearance by the Secretary of Housing and Urban Development before the Senate banking committee. HUD Secretary Mel Martinez told the panel about HUD's efforts to promote homeownership, especially among people with low to moderate incomes.

Gramm replied that he knew how to lower closing costs: Do something about title insurance, which he said costs more than it's worth.

"I want you to look at it and see what you could do about this requirement of title insurance," Gramm told Martinez. "If people want to buy it, great, but your programs are making them buy it. My guess is the social cost of not having it wouldn't be one-tenth, maybe not one-hundredth, of the cost of purchasing those policies."

Clearing the clouds
Not true, says Ann vom Eigen, lobbyist for the American Land Title Association. She gently suggests that critics of the title insurance industry do not understand what it is and where the money goes.

"No. 1, there's a title search, which is a large portion of the cost of the policy," vom Eigen says.

In fact, in strictly regulated Texas, which analyzes the title industry's finances very closely, less than 20 percent of the fee pays for the insurance policy itself. More than 80 percent of the title insurance fee goes to title agents who search records and supervise the closing. That 20-80 split generally holds true nationwide, although in some places it's closer to 50-50 and in others it's closer to 10-90.

Title agents search records for any problems that could "cloud" the title, endangering the buyer's ability to buy, use and sell the property. Mainly they look for problems in the recording of easements, court judgments, liens and taxes. They look out for mundane paperwork errors. A title agent might spot, for example, a missing signature on a document from a previous closing and take steps to correct the oversight.

How far title agents look back is a matter of law, local custom and even intuition. They sometimes go back 40 years or more. Title companies tell ALTA that they find problems in one-quarter of home sales. Most of those problems are fixed in time for the closing to take place.

Insuring the past
Another cost is the insurance policy itself. Title insurance is unusual. It protects against past events, whereas other kinds of insurance protect against the possibility of future events.

"Title insurance is a risk-avoidance form of insurance, so the search and the elimination of problems that are identified in that search are very basic costs," vom Eigen says.

There are two kinds of policies -- one for lenders and one for owners. With every conforming mortgage, the lender requires lender's title insurance, and that's the type of coverage that Gramm was complaining about.

The insurance pays for any financial loss and attorneys fees resulting from a challenge to the property's title. For example, if a missing heir pops up and claims an ownership interest in the property, the title insurance pays for the legal fight. If the missing heir wins, the title insurer compensates the policyholder for financial losses.

The mother of invention
It's hard to imagine lenders going along with Gramm's suggestion and allowing title insurance to become optional. They'll still want solid evidence that a buyer bought the property in question and that the lender lent money that was secured by the property. They'll want someone to perform a title search and make sure all the i's are dotted and t's are crossed at closing. Those functions most often are performed by title agents.

"If there wasn't title insurance, we would have to invent something like it," says Jim Maher, ALTA's executive vice president.

If the law allowed buyers to veto the issuance of lender's title insurance policies, lenders would respond by raising rates, vom Eigen predicts. That's because conforming mortgages often are bundled together and sold as investments. If mortgages lacked title insurance, investors would be taking bigger risks, and they would seek bigger returns on their investments. And that spells higher interest rates for home buyers.

How seriously is Gramm's suggestion being taken? Gramm's office referred a call to the banking committee, which referred a call to HUD. A spokesman said HUD had nothing to announce.