Why You Pay For Title Insurance

Anyone who has purchased real estate has probably had their eyes glaze over when reviewing the title company’s estimate of closing costs.  You look at the document and see all these charges for things like doc fees, origination fees, title insurance, appraisals, and a bunch of others.  You scan this long list of numbers that begin with dollar signs as you look for the grand total.  At closing, you do the same thing not even thinking about what these charges are for and why is it so much.  You just sign the documents.

I want to talk about one of these costs that can be several hundred or even thousands of dollars that you are paying:  title insurance.  Many, many home buyers see this charge and don’t know what it is, and some think it’s just another way for the title company to separate you from your hard-earned dollars.  But it’s not.

When you are involved in a real estate transaction, whether buyer or seller, you generally think that the title company’s job is to be the middleman handling escrow.  They make sure that all the paperwork, and the is a whole lot of it, is in order, get the money from the buyer and lender, record the documents, distribute money to the seller, appraiser, and anyone else that agreed to get paid from escrow, figure out who owes what taxes, and all that stuff. Well, you’re right, the title company’s job is to do all that stuff.  But one part, and perhaps their most important job, is to make sure that the seller actually owns the property being sold without encumbrance so that as the buyer, you will actually own the property after escrow closes.

That’s what title insurance is for.  The title company takes on the risk if there is a problem with the title that isn’t discovered until after the transfer.  They have to straighten it out or pay the consequences.  How can that happen?  Here’s a simpler example.  Let’s say you buy a used car and six months later there’s a knock on the door.  Your visitor says, “You have my car.”  You say that you bought it and have the paperwork to prove it.  Well, it turns out that the car was stolen, and the registration and title was forged. Therefore, the guy who sold it to you did not legally own the car and couldn’t legally sell it to you, and hence you don’t legally own it.  You are then out whatever you paid for the car.

It’s a similar scenario with real estate deeds.  While property usually isn’t stolen, there can be problems with the deed which could cost you thousands of dollars to fix or in a worst-case scenario, you could find that you don’t own the property you bought and you’re out everything—and are still responsible for the mortgage.  Title insurance is for this purpose.  But what are the odds of something like that happening?  Actually, very slim… in a sense.  The reason that it is so unlikely that you’ll need to ever make a claim against that insurance is because the title company will minimize their risk, which is a major role they play in the transaction.  Before they issue the policy, they audit the title to make sure it is clean.  They review the title to make sure that every transfer was clean with all the T’s crossed and I’s dotted.  They check to be sure that all taxes are paid, there are no liens, and everything is in order so that when you receive the deed, the property is yours.

But what if the title company misses something?  Well, that’s what the insurance is for.  In that case, your title insurance will cover all costs of getting the mess cleaned up. Here’s a couple of examples:

Someone once purchased property and a few months later received a notice that there was a lien against the property for back taxes totaling several thousand dollars due to the previous owner.  The lien, for some reason, didn’t show up on the title search, but the title insurance paid the lien.  A friend was co-owner with a partner of a piece of real estate.  My friend was buying his partner’s share to become sole owner.  While in escrow, the title company discovered that when they purchased the property originally, the previous owner signed over the deed personally, but the property was held in a trust and not owned personally, therefore the deed was never legally transferred.  This was a minute detail and technicality, but it mattered.  The original title company had to handle all the legal wrangling to get it straightened out.

One more anecdote here that is intended to give advice more than as a reason to have title insurance. Several years ago, when applying for a home equity loan, the title search found an unsatisfied mortgage on the property from a mortgage that had been paid off years ago through refinancing, but it still showed as active.  As is common, the original mortgage company had sold the loan to another mortgage company.  Once that loan was paid through the refinance, years later that company was bought out by a large, major, national bank.  I needed to get documentation from that bank that the loan was, in fact, paid off. How hard can that be (I ask with total sarcasm)?  Try calling a major bank, telling them that years ago they bought a small mortgage lender, and I need documentation about one of the loans that was paid off well before you acquired them.  Needless to say, they didn’t even know if they had that documentation, let alone where it might be.  Luckily, I was able to find the letter of reconveyance sent to me when the loan was paid off and that sufficed to get my new loan.

The lesson here is to make sure that you keep all documentation on mortgages and have a solid paper trail from application to payoff.  Had I not had the letter of reconveyance, it could have taken months and hundreds of dollars in legal fees to get it straightened out.

Bottom line, don’t get upset about the cost of title insurance, it’s worth it.