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In a real estate transaction, title insurance protects the buyer against potential losses due to property title issues. There are two types of title insurance: owner's title insurance and lender's title insurance, both of which cover borrowers and lenders in case a third party makes a claim against the property in question. For instance, title insurance can recoup your and your lender's losses if the property has any liens or easements.

Gaining a deeper understanding of title insurance, its coverage and its role in safeguarding property ownership rights can help ensure your property remains protected from potential complications.

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What Is Title Insurance?

Title insurance protects against potential damages or financial losses caused by third-party claims on your title in a real estate transaction. During the purchasing process, the deed or "title" you receive signifies the transfer of the property's legal ownership from the seller to you. However, even after the purchase, third parties can file claims against your property's title that can put your ownership at risk.

Before your real estate transaction is finalized, your lender may hire a title company to conduct a thorough search. The title company will examine various public records like deeds, mortgages, court judgments and tax records to identify any issues or "clouds" on the title.

Title issues can arise due to a myriad of reasons, such as:

  • Unpaid taxes from previous owners
  • Disputes with contractors who claim non-payment for work completed before your ownership
  • An overlooked heir, for instance, may hold ownership rights without anyone knowing about them.

If any such issues arise, the title company will strive to resolve them through collaboration with the seller's agent or by seeking alternative solutions. Their expertise ensures a smooth and secure real estate transaction for both the buyer and the lender.

Types of Title Insurance

There are two types of title insurance: an owner's and a lender's. Both play a crucial role in protecting the two parties in a real estate transaction.

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    Owner’s Title Insurance

    Designed to protect the homebuyer, this policy guarantees against potential hazards. It typically covers risks such as conflicting ownership claims, outstanding lawsuits, liens, errors in public records, fraud, forgery and undisclosed easements that may limit property usage. The coverage amount for owner's title insurance is typically equal to the property's purchase price and remains constant for as long as the homeowner or their heirs own the property.

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    Lender's Title Insurance

    Also known as a loan policy, this insurance protects the lender and provides coverage up to the loan amount in case a title defect arises at any point. If there are any title issues, this policy will pay the lender the mortgage they were supposed to receive. However, as the loan is paid off over time, the coverage amount decreases accordingly. Unlike owner's title insurance, borrowers are required to purchase a lender's title insurance policy when obtaining a mortgage.

Overall, while lender's title insurance is a prerequisite for obtaining a mortgage, owner's title insurance offers buyers an added layer of security. Both owner's and lender's title insurance play crucial roles in a real estate transaction, providing comprehensive protection to buyers and lenders alike.

Warranty of Title

A warranty of title serves as the seller's guarantee that no other party has a claim to the property, ensuring your legal ownership. If any conflicting claims emerge, a warranty of title gives you grounds for action against the seller.

While many transactions incorporate a warranty of title as standard practice, certain situations like estate sales or auctions may not include this guarantee. In such instances, the seller may be a representative rather than the owner, potentially leading to a lack of awareness regarding conflicting claims. Thus, having owner's title insurance can help you safeguard your interests fully.

How Does Title Insurance Work?

If the title company finds an undiscovered lien or if you have a lawsuit against your property, your owner's title insurance protects you from potential financial burdens. For instance, if you unintentionally purchase a property with a forged deed from a fraudulent seller, you no longer need to pay the mortgage, and your policy can provide you with a cash settlement.

On the other hand, a lender's title insurance policy may not directly benefit you as the borrower, but it protects the lender's financial interests. In case of a fraudulent property sale or unresolved title issues, the lender can file a claim with the title insurance company to recover the expected mortgage payments. While working with a title company reduces the likelihood of encountering post-purchase title problems, having a title insurance policy offers added protection and peace of mind to both buyers and lenders.

What Does Title Insurance Cover?

Title insurance policies, particularly owner's title insurance, protect you from a wide range of potential hazards related to the property's title. Some of the main benefits of title insurance are that it covers the following issues:

  • Liens
    Liens can get placed on the property by a contractor, tax authority or lender who hasn't been paid. These claims can arise from unpaid bills by previous property owners or contractors who worked on the property. If these liens come to light after the property purchase, the current owner could be held responsible for the unpaid debts. However, title insurance helps mitigate this risk by covering the cost of addressing these liens and protecting the homeowner's investment.

  • Easements
    Easements grant someone else the right to use your property even though you are the legal owner. For example, utility companies may have an easement allowing them to access your property to maintain utility lines. As a result, easements can restrict your full control and use of the property, making it essential to be aware of them before purchasing. Title insurance ensures that you know of any existing easements before purchasing the property, thus avoiding surprises that may impact property usage and ownership rights.

  • Encumbrances
    Encumbrances encompass not only liens and easements but also extend to encompass a variety of restrictions placed on the property. This may involve zoning laws that dictate how the property can be used or restrictive covenants imposed by homeowners associations. Leaseholder rights can also be considered encumbrances, limiting the owner's freedom to change or use the property as they please.

Title insurance helps you navigate these complexities by providing coverage and financial protection in case of disputes or challenges arising from these encumbrances.

Title insurance also covers you if there are any:

  • Forged documents
  • Documents that have been recorded incorrectly
  • Errors in property surveys
  • Errors on the property deed
  • Disputes over boundaries
  • Previous owner's violations of building codes
  • Conflicting wills
  • Ex-spouse's claims that the sale was not approved
  • Encroachments

What Does Title Insurance Not Cover?

While title insurance is a crucial safeguard for homeowners, there are specific situations where title insurance does not provide coverage. Homeowners must understand these exceptions to make informed decisions and take appropriate precautions.

  1. Title problems caused by homeowner's actions: Title insurance does not protect homeowners against title issues resulting from their own actions. For instance, if a contractor claims a lien on your property due to non-payment, title insurance won't cover you.

  2. Eminent domain: Title insurance does not protect against eminent domain, a situation where the government seizes private property for public purposes. In such cases, compensation is usually provided, but title insurance won't cover it.

Overall, title insurance is designed to shield you from potential title issues that could have influenced your decision to purchase the property.

Do You Need Title Insurance?

Lender's title insurance is often a requirement if you're taking out a mortgage, as it's meant to reduce the risk of title claims for the lender. On the other hand, owner's title insurance is not a requirement — but it's still a good policy to have to protect your property.

Not having title insurance may result in costly expenses if your property has an unexpected title defect. For instance, if your property has any unpaid property taxes or fines for code violations, you will bear the financial burden. Overall, despite not being required, it's prudent to have title insurance if you want to avoid any costly expenses down the road, as it will protect you for as long as you own the property.

About Mark Fitzpatrick

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Mark Fitzpatrick is a senior content director at MoneyGeek with over five years of experience analyzing the insurance market, conducting original research and creating content that can be personalized for every buyer. He has been quoted on insurance topics in several publications, including CNBC, NBC News and Mashable.

Mark earned a master’s degree in Economics and International Relations from Johns Hopkins University and a bachelor’s degree from Boston College. He is passionate about using his economics and insurance knowledge to bring transparency around financial topics and help others feel confident in their money moves.