If you’re considering purchasing a home you may have heard your real estate broker or lawyer mention something called “title insurance.” It may have been mentioned in the context of the closing costs of your mortgage, or perhaps in the context of performing a title search. Home buyers can compare title insurance policies or they can choose the default policy used by the lender.

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By definition, title insurance is an indemnity product designed to protect both lender and owner against financial loss in the case of title defects or unknown liens. The various states have different regulations regarding the necessity and cost of title insurance, as do lenders. Home buyers would do well to understand the regulations in their state when considering purchasing title insurance.

Three Types of Title Insurance

When it comes to title insurance there are three basic policy types: an owner’s policy, a lender’s policy, and a construction loan policy. All three policies are designed to cover the various parties involved in buying and selling real estate. We’ll begin our discussion with the lender’s policy, as this is the one most people are familiar with.

Lender’s Insurance:

Almost every state requires lender’s title insurance by law. A lender’s policy protects your mortgage lender against financial loss in case there are any title defects or outstanding liens that were not uncovered during a title search.

For example, if there are unpaid taxes due on the property, and the title search did not make those known, the mortgage lender needs to be protected in case the government seizes the property to pay taxes. The policy will cover the lender up to the value of the mortgage.

When you purchase a home, lenders will sometimes pass the cost of title insurance on to the home buyer. This cost is absorbed as part of the standard closing costs. It is generally a negligible amount, but it is an added cost nonetheless. You will most likely have no say in the policy your lender chooses.

Owner’s Policy:

The owner’s policy is usually a single fee policy purchased with the understanding that the title search company performed all due diligence in making sure the property title is free from defects. The owner’s policy protects him against loss in case circumstances at a later date dictate his property is unmarketable, or it is determined he has no legal access it.

The typical owner’s title insurance policy will cover him up to the purchase price of the property. Additional endorsements can be added to these policies to protect against other contingencies your real estate broker or attorney may be aware of. A policy will remain in force as long as the owner or his estate retains an interest in the property.

When it comes to the owner’s policy, this is where you are free to compare title insurance rates. While most people tend to rely on the standard policy recommended by their attorneys or real estate brokers, you do have the right to do your own research and purchase your own policy. One of the best parts of owner’s title insurance is that the single fee paid at the time of the title search keeps the policy in force with no future payments required.

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Construction Loan:

The third policy, known as the construction loan policy, is a separate policy that exists for properties in which construction loans have been obtained. Not all states have a construction loan policies; sometimes the conditions of a construction loan policy are met in the owner’s or lender’s policies. The construction loan policy is a supplemental product increasing the value of existing coverage due the fact that construction loans have increased the value of the property.

The Low-Risk Nature of Title Insurance

As you compare title insurance policies and rates, you may be surprised at how little it costs. The reason for this is the fact that title insurance is a relatively low-risk policy for insurance companies to provide. Since the mid 1800s, state and local governments have done an exceptionally good job in maintaining land ownership records, making it uncommon to find deficiencies in property titles in the U.S.

Title insurance is such a low risk in fact, that industry experts estimate title insurance companies pay out 5% of the total premiums as opposed to the 70% paid by auto insurance companies. Since insurance is all about risk and loss, insurance companies are able to provide substantial coverage if the risk of loss low. Such is the case with title insurance.

The Need for Title Insurance

Since claims against property titles are so rare in the U.S., you may wonder why title insurance is necessary. It’s necessary because potential litigation could not only cost the homeowner or lender their investment in a specific piece of property, but fees and added expenses can cause substantial losses over and above what either party has already invested. Unpaid property taxes are just one example.

Let’s say a title search failed to uncover ten years of unpaid property taxes. Those taxes could be a substantial amount when fees and penalties are added.

On a $70,000 home, the combination of unpaid property taxes, fees and penalties, attorneys’ fees, and court costs could exceed the value of the mortgage. In such a case, the owner or the lender could lose their entire investment and still have a bill to pay afterward. So while title insurance from the owner’s standpoint is not necessary, it’s a good idea that costs very little money.

Comparing Title Insurance Rates

When you’re ready to compare title insurance rates, keep in mind that different states have different regulations. For example, New Mexico and Texas are two states where rates are set by state governments with no flexibility. If you live in one of these two states there’s no point in comparing title insurance because there will be no difference from one provider to the next.

The remaining 48 states have varying degrees of regulation which make comparing title insurance something to look at. States like New York and New Jersey use a state rating agency to approve rates, but those rates are approved on a case-by-case. In states like these, comparison shopping is an option.

Fortunately, most states regulate title insurance on a “file and use” basis. This means that insurance providers must file their rates with the state government, but they are still free to set them as they see fit. “File and use” states are second only to unregulated states in the variety of rates available. Examples of unregulated states include Alabama, Indiana, and Oklahoma.

If you’re buying a new or second home, expect the issue of title insurance to come up. You are free to choose the default policies offered by the lender, and in most cases those policies are suitable. But if there are any extraordinary conditions pertaining to the property you’re purchasing, make sure your title insurance will cover you against any possible issues.

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