When buying a house or selling a house, it is important to know what title insurance is and how it works. Typically the seller of a home pays for the title insurance (not always) and it guarantees the buyer will get clear title. Clear title means there are no other liens or loans from the previous owner that are not paid off at closing. There are different types of title insurance coverage and different types of deeds a buyer can get when purchasing a home. Every state has different laws, and it is important you check with local experts to make sure you know how title insurance works in your area and what the costs will be. There are also some instances where you cannot get title insurance, which greatly increases the risks for a buyer.
Why does a buyer need title insurance?
It is very important that buyers get title insurance to ensure a lien or loan they are not responsible for is not attached to the property they are buying. A contractor can attach a lien to a property if they are not paid for a job they complete. If someone does not pay a credit card bill, a judgement can be placed against the person and their house. When you get a loan on a home, the lender uses your house as collateral. If you sell that house, the loan has to be paid off. If a loan, judgement, lien or any other encumbrance is still owed on a home when it sells, the new buyer will have to remove that encumbrance before they can sell the home or refinance it.
If a buyer is a getting a loan on a house, the lender will almost always require title insurance. The lender requires certain things be taken care of to make sure they do not lose the money they loaned the buyer. A buyer must also get homeowner’s insurance and pay the property taxes, because the lender requires it. The lender requires the buyer to get title insurance in order to make sure there are no liens or judgments that could still be owed on the home. Those liens would have priority over the new loan if they were not paid off before the home is bought. Property taxes almost always get first priority and if they are not paid, someone could buy the home through a tax auction, which would wipe out any loans and the lender would lose all their money.
Title companies guarantee all the liens or previous clouds on the title are clear before the buyer purchases a home when they issue title insurance. If the title company misses anything, they will fix the problem at their own cost. As a real estate agent and real estate investor, I have seen a few cases where the title company missed problems with the title. In one case HUD did not actually own a house when they sold it! HUD is a government agency that sells foreclosures, and they did not get clear title from the bank who foreclosed on the property. HUD found the mistake 6 months after selling the house, and luckily the buyer paid for title insurance and the title company fixed the problem.
Why does the seller pay for title insurance and how much does it cost?
Different states have different rules for how title insurance is handled. Some states like Texas mandate how much title companies can pay for insurance. Title insurance in Texas is much more expensive than it is in Colorado where I live and work. In some states attorneys may be used for closings and in others title companies. It is important to talk to your real estate agent to see how title insurance works in your area and how much it will be. In Colorado title insurance might cost $1,000 on a $200,000 house, but in Texas title insurance could be twice that amount and in states that use attorneys, the cost could be even higher.
When selling a house the real estate commissions and title insurance are typically paid by the seller. The seller pays for these costs because buyers usually do not have much extra cash when buying a home. The seller will have money from the sale of their home. The more costs a seller can cover, the more buyers there will be and the higher home prices will be. Even though the seller pays for this cost, in the end it benefits them because housing prices will be higher than if the buyer paid for those costs.
When does the seller not pay for title insurance?
The seller is not forced to pay for title insurance by law, but this practice has been adopted in most areas. HUD does not pay for title insurance when they sell houses. If you buy a home from some auctions or foreclosure sales, you may not receive title insurance from the seller either. The buyer can still get title insurance in most cases, but they will have to pay for it themselves.
With some banks REOs (foreclosures), the bank will agree to pay for title insurance if the buyer uses their title company. Typically the seller chooses the title company who will close a transaction, and the buyer usually picks the same title company. If the buyer decides to use the bank’s title company, the bank will pay for title insurance, but if the buyer chooses a different title company the bank will not pay for any of the title insurance or closing fees. Usually the buyer and seller split the closing fee, which is what an attorney or title company charge to complete a closing.
A seller may ask if banks and HUD do not have to pay for title insurance, why should I? Most REO properties and HUD homes are priced below market value and the buyer is getting a good deal. If you want to sell your house for less money, and not pay title insurance you could do that, but it doesn’t make much sense.
Buyers must be very careful about buying homes from foreclosure auctions. There is usually no title insurance guaranteeing title on a home. There is even the chance a buyer could purchase a home at a foreclosure sale that has other loans against it that must be paid. You could pay $50,000 for a house at the foreclosure sale thinking you got an awesome deal, but then find out there is another $150,000 loan you are still responsible for!
Why do different sellers offer different types of deeds?
Another thing to watch out for when buying houses is the type of deed that is being offered by the seller. In most cases a general warranty deed is used, which transfers all the sellers rights to the new owner and guarantees full title. A special warranty deed could also be offered, but only guarantees title for any liens that occurred from when the current seller has owned the property. Most REO sellers offer a special warranty deed, and although it sounds a little risky, I have never had any problems with a lien from the previous owner showing up at a later date. Banks foreclosure on the properties they own, and the foreclosure process wipes out almost all liens. Any liens that do survive (property taxes and city liens usually survive a foreclosure) can still be found by the title company and are not a secret to the buyer.
The riskiest type of deed is a quit claim deed, which guarantees nothing and most title companies will not insure a quit claim deed. The quit claim deed is sometimes offered by REO sellers on online auctions. All a quit claim deed does is transfer title from one owner to another, and it is not required that any liens be paid off. The owner of a house could owe $500,000 against a home and quit claim that home to someone else without paying any of those liens. The liens would stay with the home and the previous owner who sold the house. This is basically the same deed that is given to someone who buys a house from a foreclosure auction. A foreclosure auction is the auction the sheriff, trustee, or courts conduct to complete a foreclosure. A REO auction is an auction that is conducted on homes that have already gone through the foreclosure auction and the banks already own.
On most transactions the buyer will receive a general warranty deed and they will not have to worry about the other types of deeds. When you get title insurance, the title company or attorney can advise the buyer what protections they will receive with the title insurance. As you can see, it can become complicated figuring out the different deeds and how liens are handled. Title insurance is very important to buyers.
What are some other things to consider with title insurance?
There is also basic title insurance and extended coverage in some states. Basic title insurance insures against any recorded liens, and extended coverage insures against unrecorded liens. It costs extra to get extended coverage and some sellers will not pay for it (HUD, REO), but it is usually a good idea to get full coverage on any house you buy.
If you are flipping houses some title companies will offer hold open policies, which allow someone to buy a house and pay more for a hold open policy. If the buyer sells that house in a certain amount of time, that same policy can be used without purchasing a brand new policy. This can save the buyer a lot of money on title insurance.
Title insurance can be confusing, but the title company or attorney you use to buy or sell a home can walk you through how it works in your state. Most buyers will never have an issue with title insurance or deeds, but when buying from auctions or buying without a title company or attorney you have to be very careful.