A couple of times a month a client will ask “Is title insurance required” or “Should I purchase title insurance”?
Is Title Insurance Required?
Whether it is required is easy. It is not. You may purchase and sell real estate without title insurance, provided the buyer does not finance part of the purchase price. Commercial lenders almost universally require title insurance to insure the priority and validity of their lien.
While you, as a buyer may not be required to purchase insurance, if your lender requires it then effectively, you, as the borrower, must purchase it for your lender.
There are two basic types of title insurance: Owner’s title insurance which insures the title to the property for the benefit of the owner and mortgagee’s title insurance which insures the lender. In Texas, if you purchase one type of insurance — either owner’s or mortgagee’s insurance — the other can be added for the nominal cost of $100. If the mortgagee’s policy is less than the purchase price of the property, the cost will be $100 plus the cost of the added coverage over the loan amount but the cost of adding the coverage is still usually nominal.
What Is Title Insurance?
Before we discuss whether you should purchase title insurance, let’s explore what title insurance is and what it does.
Title insurance is unique in that most of the cost of the policy – as much as 80% — is devoted to checking the property’s title history, to discover if there are any title issues, and to closing the purchase of the property.
Title insurance protects the insured party, either the owner or the loan company, from financial loss resulting from defects in the title to the property. Both the owner’s policy and the lender’s policy are a one-time, upfront cost — not a monthly premium added to your mortgage payment.
Before a buyer closes the purchase of property and pays the seller, the title company will run a complete check on the title history of the property. This process will disclose any title defects such as unpaid taxes, unpaid mortgages, federal or state tax liens, improper foreclosures in the title history, problems caused by the death or divorce of a prior owner, and a myriad of other potential defects. If a survey is available, it will show any encroachments across the property lines or any encroachments of improvements on the property into public utility easements, building setback lines and various other issues.
After a title company completes its title history review and reviews the survey if one is available, it will issue a title commitment to the owner or lender listing any title defects found. Some of those title defects, those listed in schedule C of the title commitment, must be resolved before closing, Others, those listed in schedule B, will not be resolved but will be listed as exceptions on the title policy to be issued after closing. It is the responsibility of the buyer or lender to review the title commitment to make certain that the listed exceptions are acceptable.
If the listed exceptions are satisfactory to the buyer and the lender, the transaction will be set for closing. The title company closer will coordinate between the parties to get the required documents from the lender and seller and will conduct the closing.
Most of the title insurance premium is to compensate the title company for the services provided in checking title and closing. Less than 20% of the one-time up-front title premium is to pay for actual insurance. That 20% pays for a title insurance company to assume the risk that some title defect has not been discovered. When an owner obtains an owner’s title insurance policy and there is a claim not discovered and eliminated before closing, the title company assumes the risk of defending the title in court or paying off the claim if it is valid.
Should a Buyer Purchase Title Insurance?
This question is difficult to answer because it relates to the risk tolerance of the buyer. The possibility there is a title defect is usually small, but if there is one, the downside is up to the cost of the property.
There are certain “red flags” which can alert a buyer that the risk of title defects is higher. For instance, if there has been a recent foreclosure, or the seller has had financial difficulties. Death and divorce can also cause significant title issues. Recently constructed improvements can also increase the risk profile.
Ultimately, assuming the buyer is not borrowing funds to purchase the property, the choice is discretionary with the buyer. If you choose not to purchase title insurance you are giving up the work a title company does before closing to find and resolve title problems and you are giving up the actual insurance which would protect you even if the title company did not find and resolve a title problem.
If you are willing to risk the purchase price of the property, as small as that risk may be, then do not purchase title insurance. If you want the peace of mind of knowing that if there are title problems, you have an insurance company with the financial resources to resolve them or to pay you if you suffer a loss, you should purchase the insurance.