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October 21, 2015

Best Practices: What is Title Insurance, Anyway?

by Jessica L. Conn

Title insurance is often a requirement in real estate transactions, but what is title insurance and why is it important? Title insurance provides coverage to a person holding an interest in real property against a loss caused by a defect in title that is present at the time of the closing.

The person holding an interest in the real property is either the owner of the real property or a lender that is obtaining a lien against the real property. The owner of the real property obtains insurance for the deed conveying title and insures that the seller actually had clear and marketable title at the time of the conveyance. A lender’s policy will insure the mortgage evidencing its lien – that the fee owner held title and that the lender obtained a particular lien position.

A claim on a title insurance policy can only be made once there has been a loss. This means that even if a defect in title has been discovered, unless the insured person has had an actual loss, they cannot place a claim. For example, if a lender determines that there is an intervening lien ahead of its insured lien, unless the borrower has defaulted and the lender has been unable to recover for the full amount of the lien, it will be unable to successfully make a claim against the title insurance company. Keep in mind that while the amount of the lender’s insurance coverage may vary, a lender will only be able make a claim for the lesser of: 1) the fair market value of the property, 2) the amount of the loss or 3) the face amount of the title policy.

Title insurance only insures against defects in title that are in existence at the time at the time of closing. If gap coverage is obtained, then the insurance is extended to the time of the recordation of the lender’s mortgage. Anything that is recorded subsequent to lender’s mortgage will not be insured by the title policy. For example, if a mechanic’s lien is recorded after the lender’s mortgage, the lender would not be able to file a claim against the title insurance company. Keep in mind that anything appearing in the real estate records ahead of the deed or mortgage being recorded will be outlined as an exception to coverage, and therefore, it is important to carefully review the title commitment and policy to understand what documents are being excepted from coverage.

Title insurance is the only way for a lender to insure that it will be able to recover from its lien in the event of an intervening lien or a complete failure of title. When a lender does not obtain title insurance, it has no recourse if the information obtained on a search is faulty or if an intervening lien is recorded between the time of the search and recordation of the lender’s lien. Title insurance will provide coverage for these insurable events if lender suffers a loss.

SBA does not provide a lot of guidance as to when title insurance is or is not required, and relies on a “prudent lending” standard in making an assessment of whether a lender’s actions were reasonable. Some lenders choose to only obtain title insurance when they expect to be in a first lien position or when a mortgage is being filed against commercial real estate, but it is possible that the circumstances could dictate that a prudent lender would require insurance in other circumstances as well. For example, even if lender is in a second lien position, if the real estate in question has a great deal of equity and the prior lien is relatively small, the lender may want to protect its collateral value by insuring its second priority lien position. Situations should be considered on a case by case basis so that the lender can always demonstrate to SBA that it is acting in a prudent and commercially reasonable manner.

For more information regarding title insurance, please contact Jessica at 267-470-1188 or at jconn@starfieldsmith.com.