Myths, Truths, and Risks of Title Insurance.
Do you know what you’re
In a perfect world, you buy title insurance and it gives you clear title to your property. If anyone ever challenges your right to own your house and property—the title insurance takes care of it.
Cynthia and Jim just moved into their dream Victorian house in San Francisco. They’d gotten their loan approved, inspected the house, and finally signed the papers.
Two weeks later, they got an unexpected call. “What are you going to do about the $200,000 loan that’s outstanding to our bank?” the caller asked.
“What, $200,000 loan? We didn’t borrow money from your bank,” Cynthia protested.
“Our bank holds a mortgage note against your house for $200, 000,” the caller maintained. “How will you pay this?”
After an initial panic, they called their title company. They’d bought title insurance and were granted a clear title.
For Cynthia and Jim, the problem went away.
The title company may have shown the bank the paper trail proving that loan was paid off. Or the title company paid off the loan because they had insured against this kind of claim. They had guaranteed the clear title.
It doesn’t always work this smoothly. Here are six ways you expose yourself to risk and loss with ignorance about title insurance. Know what to look for. Watch for danger signs.
Only Your Lender Might Be Insured
Old Republic Title Insurance Company defines Title Insurance this way:
Protecting purchasers against loss is accomplished by the issuance of a title insurance policy, which states that if the status of the title to a parcel of real property is other than as represented, and if the insured suffers a loss as a result of title defect, the insurer will reimburse the insured for that loss and any related legal expenses, up to the face amount of the policy. (http://www.oldrepublictitle.com/newnational/resources/primer/whatistitle.asp)
Essentially, you pay a one-time fee for protection against things that have happened to your property in the past. There are several key limitations. Look at the importance of these terms.
- Protects purchasers against loss
- Your property is other than represented
- And you suffer a loss as a result of the title defect
- You are insured up to the face value of the policy
In #1 you must be aware that there are two purchasers in most real estate transactions—the lender and the buyer. Thus, there are two title insurance policies.
Lenders require their own title insurance policy that protects them for their loan value. Buyers also need protection against issues that are not necessarily financial, but still, critical to the home owner.
If you only purchase a lender’s Title Insurance, you will be left on the hook for many risks. Your lender only requires their title insurance. Be sure to get your own policy.
We’ll also come back to points 2-4 and explain why they matter to you.
You’re Not Insured for Every Risk
There are many things that can blight a title. First American Title Company has a free pdf: “Why Title Insurance is Important” that lists 6 categories and about 40 risks to your title. For a complete list go to: http://www.completetitle.com/pdf/WHY_TITLE_IN_IMPORTANT_WP.pdf
Title defects include:
- Human error in recording
- Missing heirs
- Tax issues
- Unrecorded liens or mortgages
- Insanity or duress in documents
- Corporate or entity documentation errors
- Taxes, Judgments, Special Assessments
- Homeowner or condo association fees
- Workmen’s liens
- Misrepresentations of wills, deeds
- Spouses, Divorces, Bigamous Relationships
Typically these defects are found, identified, corrected, and insured by your title company. But not always.
If the title company can’t identify or clarify every risk… but it thinks there might be a risk, it can simply exclude it from the policy. Under exclusions you might see something like:
Exceptions from coverage:
1. Easement or claims of easements not shown by public records.
2. Any lien or right to a lien for services, labor or materials heretofor or hereafter furnished, imposed by law and not shown by public records.
What this means is if someone claims an easement that hasn’t been shown by public record, you’re on your own for the legal fees to protect your property.
If a lien comes up that’s not on public record… you get to deal with it.
When you recognize this, you can look for those exclusions and possibly protest them. At the very least, you know what your title insurance does and does not do.
You Don’t Own ALL the Property.
Title insurance tells you who else has rights to your property. You own the right to live there, but, other people or entities may have claim to a substantial part of your property. This erodes your rights and may restrict your full use of the property.
- Earlier in your property’s history, some of these rights may have been sold, agreed upon, or appropriated.
- Restrictive covenants or homeowners association restrictions.
- Easements—utility companies, street easements, right of access for someone to cross your property
- Government restrictions such as set-backs or wetlands designations
- Mineral rights sold off
And you may have problems accessing your property
- No legal right of access to or from your land
- Unmarketable title
Your title company will identify these issues, but will not insure you for them. They become known risks to you and your responsibility. At times this is a deal-breaker and you walk away from the closing. Other times you accept the risks.
Emily and Herb put an offer in on a little ranch in south west Texas. The title search disclosed no legal right of access to the property and that the oil rights had been sold off.
Emily and Herb negotiated with the neighbor to grant a legal access and went through with the purchase.
One day a huge oil rig pulled on their front lawn and started drilling for oil.
Herb was outraged and called his attorney. The fine print in the oil rights said the owner could access the surface to drill if needed. The title company had no obligation since they disclosed the restriction in the title policy.
Herb and Emily are now owners of a house with a well on their lawn.
You Get “No Coverage” Title Insurance
Title companies spend only about 5% of their premiums on claims, unlike home owner’s insurance companies which typically pay 70% of each premium dollar on claims.
Why so low? Title Insurance companies work to reduce their risks. Closing companies track down the paper trails that prove ownership. They check deeds, mortgages and releases, wills, and other documents.
With properties that are sold frequently, title companies may only look at the transactions and time frame between sales. They may trust the research of the former insurer for the distant past history.
Sometimes this results in gaps if the previous title company is no longer in business or insured the title in a limited way.
A house that has been owned by a family for generations will take much more work to check for tax errors, workmen’s liens, easements, and so on. In this case, it might be impossible to find all the documentation.
Title insurance companies may reduce their risks by disclosing and eliminating certain items from their policy. They may say:
Exceptions from coverage:
1. Deed of trust dated October 5, 2005 and recorded October 25, 2005 in book xxx Page xx of St. Louis City records from REEP, LLC to Nathan Smith, Trustee for Hot Shot Investment Co. securing a note for indebtedness therein of $55,000.
2. Deed of trust dated January 12, 2006 and recorded January 15th in Book xxx Page xxx of St. Louis City records from George Jones Family Trust to Edmond Shaker, securing a note for indebtedness therein of $42,000.
This means that if REEP LLC ever comes after you for his $55,000—you’d be on the hook for it.
I can hear you complaining. How can they do that? Answer: They are a business. It’s their job to reduce their risks.
Usually the closing company researched enough to know that REEP LLC no longer has a claim on your property. There may be a paper trail that the LLC has been dissolved, a copy of the paid off note or other evidence. But the release of the lien may not have been filed at the courthouse.
If the loan was from an individual, it may be impossible to find that individual. Then, the title company really has no idea if the loan has been paid off or not.
Go back to the title company and have them either research it more and fix it, or insure for it.
When Over-insurance is really Under-insurance for You
When a company has been dissolved or it was a private party lender, getting those last documents discovered, resigned, and re-filed can be difficult to impossible.
Some title companies are more lax that others. If the research gets too difficult, they may not cover the risk. Or they may “over-insure” it.
Here is where the definition of the Title Insurance comes back into play. Remember points 2-4?
- 2. Your property is other than represented
- 3. And you suffer a loss as a result of the title defect
- 4. You are insured up to the face value of the policy
If your property turns out to have a lien from an old mortgage (2) and they come after you for it (3) you are insured up to the face value of the policy (4).
But what happens if you buy a repo or a foreclosure and spend money fixing it up? Then if you get a claim… what will the title company pay you? The face value.
Don bought a dirt-cheap duplex in St. Louis for $15,000. It needed new heat and air, a new roof, paint, refinishing the floors, and appliances.
But Don had done the math and the ROI would be fantastic. He bought the place and put in $50,000 of work. Soon is was up and rented and doing well.
Then, REEP, LLC came along and said, “This property has a $55,000 lien on it. You need to pay up, or we’ll foreclose.”
Don called his Title Insurance Company.
“Yes,” they said. “We did over-insure for that risk, since we didn’t take the time to track REEP or its successors down. We decided we’d just pay if the problem arose. We’ll send you a check for $15,000.”
Don just learned the hard way that title insurance on a repo or foreclosure can be under-insurance.
Don could have gone back to the title company with an appraisal after the repairs and updated his title insurance (for a fee.) Some title insurance policies allow you to escrow repair costs and will insure for the total value. Or Don might have checked the fine print of the title company policy before he bought it and required over-insurance up to the risk.
Don might have checked out other title companies. Some title companies will “over-insure up to.” This means that the face value may be $15,000, but if any of the outstanding claims come forward, they will insure for the value of the outstanding claim. In Don’s case, that would be the $55,000.
That means that ONLY in the case that REEP LLC comes after Don would they pay $55,000. Only in the case of the George Jones Family Trust coming forward would they pay $42,000. In all other cases, they would only pay out the $15,000 face value.
Your Title Insurance Gives you a “Cloudy” or “Unmarketable” Title
When foreclosures happen, most often, the mortgages recorded after that foreclosure become invalid. The foreclosure cancels them out. But not always. And mortgages recorded before have priority over later mortgages. A clear title search spends time getting the banks and individuals to sign the documentation and file it.
Again, if those loans were from private parties—non banking institutions—they can be hard to trace and absolutely document.
Then the title company may just decide to over-insure. The risk for them is low– $15,000– and they think the risk of any of the former mortgage owners stepping forward is slim.
So you buy the house and the insurance and everything is fine. No former loans come back to haunt you.
Then you go to sell your house. Remember that I previously said that title companies may just search back to the last title insurance. If you go back to your original Title Company A, they have accepted the risk and will write a new policy continuing the insurance.
But what if your buyer doesn’t want to use your old Title Insurance Company A? The new Title Insurance Company B runs their checks and discovers one, three, or five un-closed out loans on the property—ones that Title Co. A. over-insured for.
Title Co. B does not want to assume that risk. It may take months for the closing company to do the research to clear up these former loans or liens or other clouds on the title. Your closing will be held up during that time.
Title Co. B may go back to Title Co. A and ask for a letter of indemnification. This means that Title Co. A will continue to hold the risk and responsibility for the past title issues they insured over, even as Title Co. B insures for everything else.
But what if Title Co. A’s insurance was below the value of the loans—as in Don’s case? The new buyer will reject those terms. Title Co. A might increase the value of their coverage to cover those specific issues. They might go back and clear the issues. Or they will not.
If they cannot clear the issues and if they are unwilling to issue a letter of indemnification, then you no longer have a clear title to your property. If you cannot sell it with these problems, you have an “unmarketable title.”
Have you suffered loss because of the title? Yes. Are you entitled to compensation up to the face value of the policy? No. Because Title Co. A will claim they are willing to insure it… even if it’s below value. Also because no one has brought a claim against the company (remember #4 above) they need not pay out.
But you are left with a property essentially without a marketable title.
How much better off you would be if you understood the benefits and risks of title insurance?
Know Your Title Company and What Your Policy Says
Now you understand why it’s vital to read your title policy. Insist on seeing the coverage before you sign your closing papers. You will not get the title policy at the time of closing, but you should get a “Commitment for Title Insurance.”
This document will tell you what the title company plans to insure and plans to exclude. It will tell you who is the insured and what the policy amount will be. Typically that amount is the cost of the property.
You also need to know your closing company. Some are detail oriented and sticklers for finding every paper trail. You want this kind of company. Some are less honest.
There is a new law, courtesy of one closing company. This is what happened.
The agent took in all the fees for closing and for issuing title insurance. She also seemed to have a luxurious lifestyle. She traveled. She had nice cars.
One day, one of the owners she closed for had a title problem. They contacted their title insurance company.
Imagine their dismay when they learned they had no title insurance at all! The fees had never been paid. No policy had been issued.
The agent had been taking the title insurance fees and spending them on her lifestyle. Suing the agent produced little financial benefit, and the owner was left to resolve the title issue.
In response, the government instituted an insurance policy to insure the closing companies obtain the title insurance. For $20 you can be insured so you can be assured that your payment of title insurance actually went to purchase your policy.
If you know your closing company and have a long history with them, you may want to wave that fee. If it’s a new closing company… you may want that peace of mind.
Often title insurance seems mysterious and complex. The paperwork is lengthy and comes after we close a property. We seldom need it.
I encourage you to reassess the importance of title insurance before you buy. This is especially important before you buy a repo. Check these six danger places.
Know what your title insurance covers and excludes. Make sure you understand each item completely. That way you will truly be insured and not be exposed to unexpected risks.
Then your real estate investment can be a source of peace and profit.
When your company needs to give their clients clear explanations of complex issues, contact Sandy Fox. She’ll help you present white papers, reports, articles or webpages that give your clients full confidence and trust in you.