Real Estate Title Insurance
Ownership of real estate is evidenced by a real estate title, a legal document that specifies the owner of a particular piece of real estate. In title theory states, the law makes a distinction between the legal title, which is held by the lender for the property, and equitable title, which is held by the borrower. When the borrower pays off the loan, then he gains legal title as well. In lien theory states, by contrast, the lender only has a lien on the property, and must go through the process of foreclosure in case of default.
However, the title does not prove ownership. Because of legal complexities and specific procedures required to transfer title, someone other than the person specified in the title document could have a superior claim to the real estate. Title defects can result because of a defective probate or will, or even an incorrect description of the property or a gap in the title records of the property. There could also be unrecorded liens against the property, or other defects to the title, such as easements.
A certificate of title or an attorney's opinion of title is a statement of opinion about the title when the certificate is issued, and based on a title search of the public records, from which an abstract of title is prepared, which is a historical summary of all transactions that have affected the title of the property. It cannot and will not show hidden defects which are not recorded, such as unrecorded liens, forged documents, or rights of parties in possession.
Title insurance protects the buyer of property or the lender for the property against unknown defects in the title. For a one-time premium, the title insurance company, which is in the business of examining public records, preparing title abstracts, and selling title insurance, issues the insurance after doing a title search on the property. The company then issues a title binder (aka preliminary report of title) which describes the type of policy that will be issued, the name of the insured, the legal description of the real estate, the interest covered, conditions and stipulations, and all title exclusions which will include all known title defects.
Title Insurance Characteristics
Title insurance has the following characteristics:
- The maximum amount paid is the policy limit, which is usually the cost of the real estate. However, an inflation rider can be purchased to protect the insured from losses at a later time when the property may be more valuable, especially in hot markets, where real estate prices may be rising rapidly.
- Offers financial protection against title defects that were unknown before the insurance was purchased, but doesn't guarantee possession or repair defects in title.
- Known defects are listed and excluded.
- Title insurance also does not protect against restrictive covenants, easements, certain water rights, zoning ordinances, or current taxes and special assessments nor does it cover any improvements to the property, such as an addition.
- A single premium is paid at closing, calculated by multiplying the insurance rate by the property value. The insurance company may also have a lower reissue rate for properties for which a title search has been recently conducted, typically within the last 2 years.
- The property is covered as long as the insured owns the property and the defect occurred before the purchase of insurance.
Coverage and Types of Policies
The standard coverage policy covers defects such as forged documents, conveyances by incompetent grantors, incorrect marital statements, and improperly delivered deeds.
Extended coverage includes, in addition to the standard coverage, defects discovered by inspection of the property and from rights of parties in possession.
An owner's policy protects the owner of the property, whereas a lender's policy protects the mortgage lender. The amount of protection declines for a lender's policy as the mortgage amount declines. The lender's policy is only for the benefit of the lender; therefore, it is highly advisable for the owner to purchase his own policy.
A leasehold policy protects the interests of a leaseholder, and a certificate of sale policy protects the buyer of property purchased from a court sale.
The Torrens System
The Torrens system was developed by Richard Torrens in 1857 to supplant the deeds-based system with a single Torrens certificate of title, which is more reliable, simpler, cheaper, faster, and more suitable. Instead of being based on a chain of deeds, where a defect in any one of them can cloud the current title to the property, the Torrens system is a method of land registration where ownership and all mortgages, judgments, and liens are recorded on a single document, eliminating the need to do a records search. However, it does not list unpaid taxes. Any claim to the property is paid by a fund established by fees collected for obtaining the certificate. Although this method of registration saves time and money, it is on the decline in the United States. Less than 10 states now use the system to some extent, and many of those are phasing it out. Another similar system is the Title Guarantee Program run by the state of Iowa, which is much cheaper than title insurance in other states.
Glossary of Additional Terms Related to Real Estate Titles
- Chain of Title
- A title's history of conveyances and encumbrances since the original patent or as far back as historical records exist.
- Clear Title
- A title free of defects or disputed interests.
- Cloud on the Title
- A pending claim that could impair the title.
- The transfer of a real estate title to a new owner. Also, the means by which the transfer is effected.
- Any right or interest in property that affects its value, such as mortgages, taxes, easements, and deed restrictions.
- Title Report
- A document that lists title defects, liens, covenants, and easements, but does not list the chain of title.
- Under Color of Title
- Title conveyed by deed or will that was defective because the conveyor didn't actually have clear title or it was conveyed incorrectly.
The Real Estate Title Insurance Rip-off
In the United States, Texas, Pennsylvania, and New York have the highest title insurance rates, costing about $1,400 for $180,000 of coverage, compared to an average cost of $1,100 for the rest of the country.
The title insurance industry pays about 4% of its collected premiums in claims, compared to a 75% payout for auto insurance. It is argued that a good deal of the premium is used for research to prevent later losses. But considering that much of this research is stored in online databases, how much can it cost, really? Even the premiums for boiler insurance, where part of the premium is spent for onsite inspections and risk analysis, pays out 25%.
Most consumers get taken because they usually don't choose the title insurance company — insurers are usually chosen by the mortgage provider or the real estate agent. Naturally, the title insurance companies market heavily to them, but since they're not the actual buyers, the price will usually not be a consideration in the selection.
Iowa is the only state that does not allow the sale of title insurance. Iowa has a state-run Title Guaranty Program that costs the home buyer just $385 for up to $500,000 of coverage—$110 for the coverage, $150 for an abstractor who does the research, and $125 for a review by a lawyer.
Home Buying Tip: Obviously, in other states, the best way to save money is for the home buyer to buy her own insurance, and to get prices well before closing.