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May 25, 2016

Best Practices: Secondary Collateral Real Property – Title Search or Title Policy?

by Kristen G. Dickey

The Small Business Administration (the “SBA”) generally expects lenders to obtain a policy of title insurance for primary collateral real property where SBA loan proceeds are being used to purchase real property or refinance a loan secured by real property. However, the SBA has no set requirements for title insurance, and lenders may not be certain whether they should obtain a title search or title policy, for secondary collateral real property for an SBA loan. Lenders should use prudent lending standards and generally accepted principles of commercial lending as their guide in order to determine whether a “title and/or lien search or other evidence of proper ownership and lien position” for secondary collateral real property is sufficient. The best practice may be to obtain a title policy on secondary collateral real property when the lender will be placing a first position mortgage/deed of trust on the property or when there is still significant equity in the property even if there is a prior mortgage/deed of trust (or multiple mortgages/deeds of trust) encumbering it.

In general, a title search refers to a search and examination of the official or public records for recorded instruments that affect the title to the parcel of land being searched. A title search report is, therefore, a report from which the status of title can be determined. When secondary collateral real property already has a prior mortgage/deed of trust (or multiple mortgages/deeds of trust) recorded on title, a lender may determine that only a title search should be required given the equity remaining in the property. In this situation, the lender would use the title search report to confirm correct lien position and highlight any other encumbrances, such as state or federal tax liens, which may need to be resolved. If a lender has required a title search for secondary collateral real property, then it is prudent for a lender to run a post-closing title search through the date of recording of the mortgage/deed of trust to ensure there are no intervening liens since the title search report was completed that would affect priority of the mortgage/deed of trust.

Title insurance, on the other hand, is an indemnity against loss resulting from title defects or undisclosed liens on real property. A loan policy of title insurance insures that the mortgage/deed of trust has been executed in accordance with the law and is a valid lien against the real property described. When secondary collateral real property will either: (i) be secured with a first position mortgage/deed of trust; or (ii) have significant equity remaining in the property even if there is a prior mortgage/deed of trust (or multiple mortgages/deeds of trust), a lender may determine that obtaining title insurance may be in its best interest. The lender should perform a cost/benefit analysis and consider whether the cost of the title insurance (e.g. title premium, endorsements, survey, etc.) is compared to the benefit and protection derived from an insurance policy. There is always the possibility that an intervening lien is recorded prior to the recording of a lender’s mortgage/deed of trust. A title commitment assures the lender that title has been checked through the most current certification date contemporaneous with the date of closing.* The title commitment creates an obligation to write a final title policy by the same underwriter who issued the title commitment, and title insurance provides you with certainty that the lender will be in the correct lien position.

* Many states require title insurance underwriters to insure against title encumbrances recorded in the “gap” – matters that appear in the official or public records between the effective date of the title commitment and the recording date of the instrument(s) giving rise to the interest being insured. In the states that do not mandate gap liability protection, lenders should require a gap indemnity endorsement even if there is an additional cost.

For more information regarding when to obtain a title search versus a title policy for secondary collateral real property, please contact Kristen at kdickey@starfieldsmith.com or at 407.667.8811.