At every real restate closing, the buyer is handed an inventory (a HUD-1 settlement statement or its equivalent) of items for which he is being charged. It is probably safe to say that few items on this long list of "closing costs"; elicit more questions or concerns than the entry for lender's title insurance. (Note: in some states, lenders title insurance is required to be paid by the seller.)

"What,"; the buyer often asks, "is this about? I just paid $800.00 for a homeowner's policy, and $900 for flood insurance. Now I have to pay for title insurance?";

Just to compound the confusion, at about this point in the closing, the escrow agent usually asks if the buyer also wants to purchase owner's title insurance. A stressful situation gets worse, and the agent usually scrambles to explain a complicated issue to a wigged out buyer who is not in the mood to listen.

Almost all lenders require borrowers to purchase lender's title insurance as a condition of a home mortgage. This protects the lender, up to the value of the mortgage, against "defects"; in the title to the property; those that existed before the transaction but might have been missed in the title examination.

Most titles are thoroughly examined before any transfer of property and the overwhelming number are clear or require only a slight tweak to make them so. A title exam is not necessarily a legal requirement and you can probably still buy a friend's home with a handshake and a check, then mosey over to the courthouse and record the deed yourself. However, if a bank or mortgage company is involved, there will be a title examination.

But title law is a very complex branch of the legal system. Land ownership in this country goes back hundreds of years, and along the way there may have been dozens of occasions when something could have occurred to "cloud"; its ownership. Records were not always meticulously maintained, deeds and claims were not always correctly recorded. Old land grants and tribal claims still occasionally surface to cause problems hundreds of years later.

For example, some landowners on Cape Cod (Massachusetts) were thrown into limbo 25 years ago when the Mashpee Indian Tribe asserted strong and credible claims to ancient ancestral lands. It was many years before the resulting issues were settled and the current owners had clear title again. During that period, selling or re-mortgaging a piece of the clouded property was virtually impossible.

There are many more contemporaneous defects that can cloud a title.

  • An incomplete or incorrectly exercised foreclosure or tax taking;
  • Property rights that were not totally extinguished by a divorce or the probate of an estate;
  • A seller revealed, even years later, to not have actually owned the property. This may result from actual fraud or something as innocent as an expired or improperly executed Power of Attorney, and happens way more often than one might want to know;
  • Mistakes in recording (or failing to record) earlier documents, such as wills or probate decisions;
  • Liens for unpaid work (mechanics liens) or for estate, income, or gift taxes;
  • Adverse possession which occurs when someone has openly used a portion of another's property (a path to the beach or an improperly positioned fence) for a period of time without a challenge by the land owner.
  • Previously unnoticed rights-of-way or easements. These give a non-owner (the city, a utility, a neighbor) the right to use a piece of a property. Cities and utilities often demand or purchase easements to allow construction or repair of utility or sewer lines. A neighbor may have a right-of-way to access a land-locked parcel or construct a driveway.
  • Failure to extinguish a lender's rights. When a mortgage is sold to another lender or paid off by the borrower, an assignment or a discharge must be recorded transferring or canceling the mortgage. One of the real nightmares of the 1980s/1990s banking crisis were the thousands of mortgages which failed banks had not properly assigned. Without an assignment, the bank which held the mortgage could not discharge it when it was paid. RTC and FDIC, as receivers of those banks, often had no records of the old mortgages and could not know if or to whom they had been sold or whether they had been paid. Clearing these situations was both time consuming and expensive.

Not all of the above instances will be covered by title insurance. First of all, there is usually a time limit (40 or 50 years prior to the current closing is common) during which defects will be covered. Even with title insurance, the folks on Cape Cod would still have been hanging out to dry when the Mashpee Tribe asserted its two hundred year old claims. Policies almost always cover problems that did not show up during the title examination, were missed by the examiner, or resulted from errors in public records, but they may or may not cover problems with easements, mineral, or air rights, or some liens. Be sure to check the limits of your policy's liability.

But lenders, understandably, want to insure that as many as possible of these potential title problems won't end up costing them money, and lenders title insurance essentially guarantees that a title has been adequately examined and, if problems should arise, the title company will cover the expense of clearing the title or defending it in court. If title cannot be cleared, the bank will be compensated for any loss it may incur if the property is seized or loses market value.

Lender's policies do not, however, cover the buyer's share of home ownership. As buyer, you will, whether you want to or not, pay for your lender's peace of mind by buying this lender's policy. The option to insure your own equity and peace of mind is up to you, but consider the following hypothetical situation.

You purchase a property for $200,000 and mortgage it for $150,000, purchasing, as required, a lender's title policy. Two years later, with the property now valued at $225,000 and the mortgage paid down to $148,000, a long lost nephew of the previous owner (who died childless) returns from searching for gold in the Amazon and lays claim to his uncle's estate (which pretty much consists of your house.) The only other heir, his brother, sold the house without benefit of probate and is nowhere to be found. The nephew's claim can not be disputed and the sale to you is invalidated. Your bank collects its $148,000 from the title company. You lose the house and receive no compensation.

Far-fetched? Maybe not so. In any case, a risk worth avoiding.

Title insurance is a one-time expense and, while most people will never need it, it is short money compared to the disasters it may prevent or mitigate. While you will probably have to ante up another fee for lender's insurance if you refinance, the owner's portion is good for as long as you own the house. Owner's insurance on a $150,000 purchase is about $450.00, and inflation protection can also be purchased.

This is not a bad deal.

Now, however, having given such a strong endorsement for owners' title insurance, there must be full disclosure. Title insurance is an extremely competitive business, and, for at least the third time in ten years, some title companies have gotten just a little too aggressive, entering into some shady practices to corner a share of the market.

More about this next week.