Picture this: you wake up one morning to find out someone else has a deed to the property you’ve just purchased. You lose your house and your down payment… all before finishing your first cup of coffee.
Does that sound impossible? It’s not. To hedge against this very situation, homebuyers purchase title insurance. Title insurance protects you (or your lender) if the property you buy has a pre-existing claim or lien on it. With title insurance, if a legitimate claim to the home surfaces, the insurance company will compensate your mortgage lender or you, depending on what kind of title insurance you have. A simple title insurance definition is this: an insurance policy that provides compensation for financial losses stemming from a title dispute on a property.
What about the title search?
We know what you’re thinking: “But isn’t that what lawyers are for? Why did I pay to have an attorney review the title and closing documents?” The short answer is that even expert lawyers can miss something among all the documents at closing or be blindsided by a preexisting claim.
Title insurance companies will hire someone to do a title search on the property you want to buy. The title agent or attorney will come up with a sort of family tree for the property, trawling local government records to recreate the history of ownership on the home. They’ll do the digging to put together the “title chain” for the home, and determine whether any claims or liens exist against the title. This process takes place before your closing and is called a “title search.” But even title searches aren’t infallible.
What kinds of things are they looking for in the title search?
Maybe there’s a long-lost heir or estranged spouse who could resurface and lay claim to the home. It may sound like something out of Dickens, but it happens. Or maybe a former owner owes money to a contractor who repaired the home. This contractor could put a lien on the property to recoup what is owed. Only now it’s your property.
What’s a lien?
A lien is the right to take possession of another person’s property — or receive a portion of the money from the sale of the property — because of an unpaid debt. It doesn’t have to be your debt for there to be a lien on your property. For example, if the last owners of the home weren’t paying their property taxes, the IRS might put a lien on the home.
So why is title insurance necessary?
With title insurance, you and your lender won’t have to worry if these kinds of problems crop up. The title insurance company will identify and fix the problems before you close on your house and defend you if any issues arise after closing.
After the title search, the insurance company will issue a “title insurance commitment” explaining what they’ve discovered, giving the seller the opportunity to clear up any issues — and you a chance to call the sale off. If all parties are happy with the title commitment, the sale will proceed and when you close on the home, you’ll do so with “clear title” and insurance to cover any unforeseen claims in the future.
How does title insurance work?
Unlike other forms of insurance that you pay for from month to month, title insurance is paid in one up-front lump sum. At the time of closing, you’ll pay for title insurance on top of other closing costs and fees.
Title insurance comes in two forms: lender’s title insurance policies and owner’s title insurance policies. The owner’s policy protects you, while the lender’s policy protects your mortgage lender. Mortgage servicers require lender’s policies because they don’t want you to stop making your mortgage payments if a problem arises with the title on the home. This is true whether you’re buying a home or refinancing it. Because refinancing is essentially getting a new mortgage, you’ll still need to pay for lender’s title insurance when you refinance.
Owner’s policies are usually not required to secure a mortgage, but they can still be a good idea when you consider that a relatively small up-front payment could save you tens of thousands in legal fees — or save you from losing your equity if you lose a dispute over the title. It’s a lot of protection for a little bit of money.
Who needs owner's title insurance?
If you’re the type who tends to worry, owner’s title insurance will buy you peace of mind. Not only will title insurance protect you against covered claims, it will also pay your legal fees while you defend your ownership rights and pay you the amount of your home equity if you lose the lawsuit and have to move out of the home. If you die and leave the property to your heirs, the same title insurance policy will cover them while they’re in the home.
If you’re buying into a co-op, though, you can skip title insurance. Why? Because with a co-op you don’t actually buy the real estate, you buy shares in a corporation.
Who pays title insurance?
In some states, the homebuyer pays the cost of both lender’s title insurance and owner’s title insurance. In other states, the seller pays the title insurance fee. In the rest, title insurance costs are up for negotiation between the buyer and the seller. Title insurance rates vary from state to state, too.
What isn't covered?
Title insurance only covers issues that date from before you took ownership of the home. If you don’t pay your property taxes or the government decides it wants to tear down your house and build a highway, you’re out of luck — the title insurance company won’t go to bat for you.
In a perfect world, no one would sell a home without triple-checking that they had free and clear ownership of the property and could transfer the clean title over to you. In the real world, this doesn’t always happen. Title insurance is your defense against unexpected legal claims that could threaten your position as homeowner. And for your lender, title insurance provides an added layer of security.
How much does title insurance cost?
As we mentioned, title insurance costs vary from state to state. Our SmartAsset closing cost calculator takes this into account. So, when you use our calculator you’ll see an estimate for both lender’s title insurance and owner’s title insurance based on state-specific data.
In the grand scheme of your home-buying expenses, title insurance is small and often forgotten. That doesn’t mean you should skip it, though. Consider it a little investment that secures your biggest investment — your home.