Title Insurance: To Buy, or Not To Buy

Imagine that you are looking to build your dream home. You find a perfect plot nestled in a residential neighborhood. The property fronts a quiet street. To the rear is another subdivision with homes from the 1920s and 1930s. There is a short walk to good schools, and an easy commute to work. Perfect.

You prepare to build the perfect home on the perfect plot. Because you know that building a home takes a lot of cash, you are conservative with your spending. You want your hard-earned dollars to go to work building your dream castle. At the closing table you are told that buying “title insurance” is optional, so you decide to forgo the expense.

What is Title Insurance?

Title insurance is a policy that protects the policyholder from challenges to the property’s title. It effectively is the insurance company’s way of saying: “I believe you are the owner of 123 Main Street. If someone says you are not, I will protect you.”

The insurance company hires a qualified title examiner to search the title, and then issues one of two policies:

Lenders’ Policy – protects the mortgage interest held by the lender; or

Owners’ Policy – protects the homeowner.

Do I Really Need an Owners’ Policy?

A general rule of thumb is that you should buy title insurance if you will have more than 5% equity in the property. It is standard practice for lenders to require borrowers to purchase a lenders’ policies. Often borrowers improperly think that a separate owners’ policy is unnecessary because of one of two faulty reasons: (1) if there is a problem, the lender will want to fix it; or (2) someone already had to do a title exam, the title must therefore be clean.

Lenders usually step in to defend title only when they need to foreclose because. And, if they do, their policy coverage is capped at the principal of the mortgage. If there is a significant amount of equity, it could be lost. The second rationale makes the assumption that the title exam is 100% accurate. It is not. There can exist many different hidden issues that impact title that even the best examiners could never find. Which brings us back to the perfect home.

What if I Do Not Have Title Insurance?

You relied upon one of two faulty reasons to avoid title insurance. You built your perfect home for your family. Years go by without issue. A developer purchases some lots  in the adjacent subdivision behind your home. It turns out that when that subdivision was created, your plot was intended to be a street connecting to the other subdivision. You built your house on a paper street!

The developer demands that you tear down your house. Your perfect home is not so perfect any more. Your title is defective, and you have no insurance. This harsh reality is taken from a real example in a major metropolitan area. One that could have been solved with title insurance.

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