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How does title insurance work?

Yahoo Personal Finance· Getty Images
5 min read

Buying and owning a house always involves some risk, so several types of insurance policies are available to help you mitigate it. You’ve probably heard of homeowners insurance, which protects your residence and belongings under set circumstances, and mortgage insurance, which protects your lender if you fail to repay your home loan.

However, you may be less familiar with title insurance. We’ll explain how title insurance works, what it covers, and how much it costs. That way, you can be a well-informed homebuyer and confidently purchase your property.

Dig deeper: How to buy a house

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Before we get into the role of title insurance, let’s define the term “title.”

“A title in real estate references the legal ownership of a property. It details who owns and has a legal right to own the property,” said Scott Kuhn, head of retail mortgage sales at Members 1st Federal Credit Union, via email.

Title insurance covers third-party claims against the property after you finalize your purchase. For example, the coverage can protect you if an overlooked heir to the residence tries to claim rightful ownership many years after you’ve lived there — and built significant equity.

There are two types of title insurance: lender’s title insurance, which protects your lender, and owner’s title insurance, which protects you, the homeowner.

“Lender's title insurance protects the lender's investment in the property, making sure that the lender's lien on the property is valid. If you are financing the property, it is required by the lender,” said Kuhn. If a third-party claim is upheld, the insurance policy will pay your lender the outstanding mortgage loan balance.

“Owner's title insurance protects the property owner against any issues that may come about once you purchase the home. It provides insurance that would pay you for [the] challenges of your legal ownership of the property,” said Kuhn.

Learn more: How to get a mortgage

Before closing day, a title company will research your property’s history via public records (you may hear this referred to as a “title search”) to ensure the title is clear and the home is available to purchase legally. The researcher will look for any encumbrances that may restrict your right to own or use the property.

There are several types of possible encumbrances. Here are three common ones:

  • Liens. A lien is a legal claim on your home, using your property as collateral. An outstanding lien may exist if a previous owner failed to pay their property taxes or a contractor who worked on the home.

  • Easements. An easement is a right granted to a third party to use your property even though they don’t own it. For example, the driveway to access their house may run through your land.

  • Encroachments. An encroachment occurs when part of your neighbor’s property spills onto yours. For example, they may have a tree that grows so large it crosses the boundary between the two plots of land.

Once the title search is complete, the title company can issue your insurance policy.

Not every encumbrance will impact your real estate deal. However, if a third-party lien is discovered during the title search, you’ll likely need to pay it off to buy the house.

“If any title issues arise after the purchase, the insurance policy will cover legal fees and losses up to the policy's coverage amount,” said Kuhn.

Read more: First-time home buyer — What you need to know

Title insurance can cover several potential issues, such as:

  • Claims from a forgotten heir

  • Claims from a creditor of a previous owner (not uncovered in the initial title search)

  • Conflicting or contested wills

  • Back taxes owed

  • Recordkeeping errors in legal documents

  • Falsified information or a forged signature on the deed to the home

Important note: Title insurance protects you against problems a title search missed that occurred before you took ownership. It doesn’t cover issues that arise while you own the property. For example, your policy won’t help if you fail to pay your property taxes.

Dig deeper: How much house can I afford?

Yes, title insurance is a closing cost. Generally, you’ll pay for both the lender’s policy and owner’s policy as a one-time expense the day you close on your house.

“Title insurance cost varies based on the value of the property, the location, and the amount of the policy that your lender requires or that perhaps you choose,” said Kuhn. Your insurance premium could range from a few hundred to a few thousand dollars. You may be able to save money by shopping around for a title insurance company. Your mortgage lender or real estate agent might recommend a company, but feel free to do your own research to find the best policy.

In some cases, you’ll pay for the coverage. In select instances, the seller may be responsible for the expense, or you’ll have the opportunity to split the cost.

“Insurance is required if you are financing your property,” Kuhn said. “It is typically considered well worth the expense in any case, whether financing the property or not, because it provides protection against title variances that may put you in a position where your finances are significantly impacted, or where legal issues may arise.”

Chances are, you’ll never face title problems and need to file a claim. However, the last thing you want to deal with as a homeowner is a third party threatening your rights to your property. Title insurance can make a potentially devastating situation manageable.

This article was edited by Laura Grace Tarpley