A question that I am asked a lot is “what is title insurance and why do I need title insurance?” It is a legitimate question for buyers and sellers alike.
Title insurance companies have three core roles in real estate transactions:
- They conduct searches in numerous public and private databases to unearth potential “encumbrances to title”
- They work with real estate attorneys to clear any encumbrances prior to closing
- They facilitate the closing make sure that the transfer of title takes place efficiently and correctly, and that the funds are properly transferred between buyers, sellers, real estate developers, builders, mortgage lenders and others who have an interest in a real estate transfer.
We will discuss these steps below and provide context that can help understand both the what and why.
What is Title Insurance?
Simply put, title insurance protects property buyers and mortgage lenders against defects or problems with title to that property when there is a transfer of property ownership.
If you are buying a home, it is likely one of the most expensive, emotional and important purchases you will ever make. You (and your mortgage lender) want to be sure that the property is indeed yours, and that no one else can claim any interest in your property.
Similarly, if you are selling a home, you stand to pocket a large sum of money upon consummation of the contract. As a Seller, you have a legal obligation to deliver “clean title.”
The title insurance company and the Seller’s attorney go through a number of steps prior to the closing to determine whether title—the formal document that shows proof of ownership—is free and clear. That means there are no delinquent taxes, unpaid liens, undisclosed heirs or other disputes that must be disclosed and resolved before the house can be sold.
A title search and title insurance protect both lenders and borrowers. There are two main types of title insurance policies: “Owner’s policies” and “Lender’s policies.” An “Owner’s policy” policy protects a new owner in the event that an unknown issue affecting the property at the time the policy is issued later causes problems with your title to the property. A “Lender’s policy” does the same thing, but for the Lender for the life of the mortgage loan. In a transaction that involves a mortgage, both policies are issues. In a cash transaction, only the Owner’s policy is necessary. Both kinds of policies involve a one-time premium that is paid at closing.
First, the title company performs an extensive search of relevant public records to determine if any other individual or entity have an interest in the property. This search is either performed by title company personnel or a third party who conducts such searches. Multiple sources are utilized: public records, personal identification affidavits, former title policies for the same property, and other internal proprietary data previously gathered, reorganized and indexed by the title company. Because these searches are meant to be thorough, title problems are flagged early on, and can be remediated prior to closing.
After the search has been performed, the Seller’s attorney, acting as an attorney-agent to the title insurance company, reviews the findings and, if appropriate, recommends that the title insurer issue a non-binding title commitment. The title commitment is essentially the title company’s promise to issue a title insurance policy for the property after closing. The title commitment contains the same terms, conditions, and exclusions that will be in the actual insurance policy.
What is an “exclusion,”, you ask? Exclusions are the title problems I referred to earlier. They appear as “exceptions” to the policy, meaning that they are excluded from insurance coverage. If, during the time you own the home, you run into problems arising from one of these exceptions, your policy will not cover it. Common examples include spousal claims, undisclosed heirs to the property, unpaid taxes, pending legal action, errors, fraud, forgery, easements, declarations, use restrictions, and unrecorded mortgage releases.
After a commitment has been issued, the Buyer’s attorney and Lender review the policy to determine which exceptions are acceptable versus which ones aren’t. In parallel, the Seller’s attorney works with the title company to clear the exceptions.
At the same time, what is uncovered in the search will dictate the cost of the policy. Title polices are typically tied to a stair-stepped model that relates to the price of the home. However, additional coverage could boost the cost. For example, a restriction endorsement could protect you if the construction of your home inadvertently violates the restrictions of your subdivision. Similarly, your lender may want additional coverage tied to the type of loan it is giving you.
Assuming all issues have been resolved to the parties’ satisfaction and the transaction closes, the title insurer issues a “title policy”, which binds coverage. Once a title policy is issued, if a third party claims an interest in your property, as long as it was not included as an exception to coverage, the title company will pay the legal fees and costs associated with defending your property rights, as well as any covered loss arising from a valid claim. That protection, which is in effect as long as you or your heirs own the property, is yours for the aforementioned one-time premium paid at closing.
Who Chooses the Title Insurer?
In Illinois, it is usual and customary for the Seller to choose the title insurer. That does not mean, however, that the Buyer has no say in the matter. If you or your attorney have strong feelings for or against a particular insurer, it is best to raise those concerns during the attorney review period. Valid objections include but are not limited to the reputation and/or financial standing of the proposed title insurer, the Buyer’s attorney’s experience with it, and the location of the closing office if it is not near the property.
Seller’s attorneys typically have relationships with several title insurers and are often paid by the title company for their time reviewing the search. They are required to disclose this Controlled Business Relationship to all parties through the title invoice as well as a “DS-1” form that outlines total costs and the nature of the relationship. Attorneys are encouraged to disclose this relationship and the costs of title insurance as early as possible.
In order to ensure that our clients are as informed as possible, at Byrne Law, we explain it during our initial meeting with clients, in our retention agreement, when the title invoice is issued, and through the DS-1 form, and during review of the preliminary settlement statement.
Who Pays for It?
The party responsible for paying for the two policies varies from state to state. In Illinois, it is usual and customary for the Seller to pay for the Owner’s policy, while the Buyer pays for the Lender’s policy and any additional endorsements. While this is negotiable, such negotiation is very rare.
Why Do I Need It?
Two words: risk mitigation.
“Whether it’s a person buying their first house at $250,000 or someone buying a home at $10 million, you have to ask, ‘How devastating would it be to your life if you lost your entire investment?” says Rafael Castellanos, managing partner at New York-based Expert Title Insurance Agency.
Most forms of insurance assume forward-looking risks by providing financial protection through a pooling of risks for losses arising from an unforeseen event, say a fire, theft or accident. The purpose of title insurance, on the other hand, is to eliminate risks and prevent losses caused by defects in title that happened in the past. Risks are examined and mitigated before the property changes hands, making it possible to insure for a potentially massive loss with only a relatively small one-time payment. Why? Because this “look-back” minimizes the chances adverse claims might be raised, and by so doing reduces the number of claims that have to be defended or satisfied. This keeps costs down for the title company and your title premiums low.
Byrne Law will continue to provide news and updates on matters affecting the Illinois real estate community. If you have further questions, please contact Sean Byrne.