What Is Title Insurance?

Title insurance is a form of indemnity insurance that protects lenders and homebuyers from financial loss sustained from defects in a title to a property. The most common type of title insurance is lender’s title insurance, which the borrower purchases to protect the lender. The other type is owner’s title insurance, which is often paid for by the seller to protect the buyer’s equity in the property.

Understanding Title Insurance

A clear title is necessary for any real estate transaction. Title companies must do a search on every title to check for claims or liens of any kind against them before they can be issued.

A title search is an examination of public records to determine and confirm a property’s legal ownership and determine whether there are any claims on the property. Erroneous surveys and unresolved building code violations are two examples of blemishes that can make the title “dirty.”

Title insurance protects both lenders and homebuyers against loss or damage occurring from liens, encumbrances, or defects in a property’s title or actual ownership. Common claims filed against a title are back taxes, liens (from mortgage loans, home equity lines of credit (HELOCs), easements), and conflicting wills. Unlike traditional insurance, which protects against future events, title insurance protects against claims for past occurrences.

A basic owner’s title insurance policy typically covers the following hazards:

• Ownership by another party
• Incorrect signatures on documents, in addition to forgery and fraud
• Flawed records
• Restrictive covenants (terms that reduce value or enjoyment), such as unrecorded easements
• Encumbrances or judgments against property, such as outstanding lawsuits and liens

Types of Title Insurance

There are two types of title insurance: lender’s title insurance and owner’s title insurance (including extended policies). Almost all lenders require the borrower to purchase a lender’s title insurance policy to protect the lender in the event that the seller was not legally able to transfer the title of ownership rights. A lender’s policy only protects the lender against loss. An issued policy signifies the completion of a title search, offering some assurance to the buyer.

Since title searches are not infallible and the owner remains at risk of financial loss, there is a need for additional protection in the form of an owner’s title insurance policy. While lender’s title insurance is required for you to get your mortgage loan, owner’s title insurance, which is purchased by the seller to protect the buyer against defects in the title, is optional.

You might consider owner’s title insurance once you own your home since, as you continue to pay down your mortgage, you now own a greater percentage of your property. As a result, you have more to lose if a claim comes up. This is especially important if you plan on spending a long period of time in your home.

Purchasing Title Insurance

An escrow or closing agent initiates the insurance process upon completion of the property purchase agreement. There are four major U.S. title insurance underwriters: Fidelity National Financial Inc., First American Title Insurance Co., Old Republic National Title Insurance Co., and Stewart Title Guaranty Co. There are also regional title insurance companies from which to choose.

The cost of owner’s title insurance ranges from $500 to $3,500, depending on the state where you live, the insurance provider you choose, and the purchase price of your home.

Often, a lender’s policy and an owner’s policy are required together to guarantee that everyone is adequately protected. At closing, the parties purchase title insurance for a one-time fee. The Real Estate Settlement Procedures Act (RESPA) prohibits sellers from requiring purchase from a specific title insurance carrier to prevent abuse.

Risks of Not Having Title Insurance

Having no title insurance exposes transacting parties to significant risk in the event that a title defect is present. Consider a homebuyer searching for the house of their dreams only to find, after closing, unpaid property taxes from the prior owner. Without title insurance, the financial burden of this claim for back taxes rests solely with the buyer. They will either pay the outstanding property taxes or risk losing the home to the taxing entity.

Under the same scenario with title insurance, the coverage protects the buyer for as long as they own—or have an interest in—the property.

Similarly, lender’s title insurance covers banks and other mortgage lenders from unrecorded liens, unrecorded access rights, and other defects. In case of a borrower’s default, if there are any issues with the property’s title, a lender would be covered up to the mortgage amount.

Real estate investors should make sure that a property does not have a bad title before proceeding with any purchase. Homes in foreclosure, for example, may have a number of outstanding issues. Buyers may consider purchasing owner’s title insurance to protect themselves against unforeseen claims against the title.

The Bottom Line

Title insurance is a type of indemnity insurance that protects the insured from financial loss when there are claims filed against a title, such as outstanding liens, back taxes, and conflicting wills. The two types of title insurance are lender's title insurance and owner's title insurance.  Lender's title insurance is purchased by the borrower to protect the lender from these claims, and is the most common type of title insurance. Lenders almost always require the borrower to buy lender's title insurance. That's because the risk of not having this type of coverage is too great, leaving the buyer potentially vulnerable to financial risk if there's a problem with the title. Owner's title insurance is usually bought by the seller to protect the buyer against defects in the title, and is less frequently purchased.