Title insurance

Title Insurance is a form of indemnity insurance predominantly found in the United States which insures against financial loss from defects in title to real property and from the invalidity or unenforceability of mortgage liens. Title insurance is principally a product developed and sold in the United States as a result of an alleged comparative deficiency of the U.S. land records laws. It is meant to protect an owner's or a lender's financial interest in real property against loss due to title defects, liens or other matters. It will defend against a lawsuit attacking the title as it is insured, or reimburse the insured for the actual monetary loss incurred, up to the dollar amount of insurance provided by the policy. The first title insurance company, the Law Property Assurance and Trust Society, was formed in Pennsylvania in 1853. The vast majority of title insurance policies are written on land within the United States.

Typically the real property interests insured are fee simple ownership or a mortgage. However, title insurance can be purchased to insure any interest in real property, including an easement, lease or life estate.

There are two types of policies - owner and loan. Just as lenders require fire insurance and other types of insurance coverage to protect their investment, nearly all institutional lenders also require title insurance [a loan policy] to protect their interest in the collateral of loans secured by real estate. Some mortgage lenders, especially non-institutional lenders, may not require title insurance. Buyers purchasing properties for cash or with a mortgage lender often want title insurance [an owner policy] as well. A loan policy provides no coverage or benefit for the buyer/owner and so the decision to purchase an owner policy is independent of the lender's decision to require a loan policy.

Title insurance is available in many other countries, such as Canada, Australia, the United Kingdom, Mexico, New Zealand, Japan, China, Korea and throughout Europe. However, while a substantial number of properties located in these countries are insured by U.S. title insurers, they do not constitute a significant share of the real estate transactions in those countries. They also do not constitute a large share of U.S. title insurers' revenues. In many cases these are properties to be used for commercial purposes by U.S. companies doing business abroad, or properties financed by U.S lenders. The U.S. companies involved buy title insurance to obtain the security of a U.S. insurer backing up the evidence of title that they receive from the other country's land registration system, and payment of legal defense costs if the title is challenged.

1. History

Prior to the invention of title insurance, buyers in real estate transactions bore sole responsibility for ensuring the validity of the land title held by the seller. If the title were later deemed invalid or found to be fraudulent, the buyer lost his investment.

In 1868, the case of Watson v. Muirhead was heard by the Pennsylvania Supreme Court. Plaintiff Watson had lost his investment in a real estate transaction as the result of a prior lien on the property. Defendant Muirhead, the conveyancer, had discovered the lien prior to the sale but told Watson the title was clear after his lawyer had (erroneously) determined that the lien was not valid.

The courts ruled that Muirhead (and others in similar situations) was not liable for mistakes based on professional opinions. As a result, in 1874, the Pennsylvania legislature passed an act allowing for the incorporation of title insurance companies.

Joshua Morris, a conveyancer in Philadelphia, and several colleagues met on 28 March 1876 to incorporate the first title insurance company. The new firm, Real Estate Title Insurance Company of Philadelphia, would "insure the purchasers of real estate and mortgages against losses from defective titles, liens and encumbrances," and that "through these facilities, transfer of real estate and real estate securities can be made more speedily and with greater security than heretofore."

Morris' aunt purchased the first policy, valued at $1,500, to cover a home on North 43rd Street in Philadelphia.

2. Reason for existence

Title insurance exists in the U.S. in great part because of the way U.S. land records laws are structured. Most of the industrialized world uses land registration systems for the transfer of land titles or interests in them. Under these systems, the government makes the determination of title ownership and encumbrances on the title based on the registration of the instruments transferring or otherwise affecting the title in the applicable government office. With only a few exceptions, the government's determination is conclusive. Governmental errors lead to monetary compensation to the person damaged by the error but that aggrieved party usually cannot recover the property. The Torrens Title system is the basis for land registration systems in many countries.

A few jurisdictions in the United States have adopted a form of this system, e.g., Minneapolis, Minnesota and Massachusetts. However, for the most part, the states have opted for a system of document recording in which no governmental official makes any determination of who owns the title or whether the instruments transferring it are valid.

Greatly simplified, in the recording system, each time a land title transaction takes place, the parties record the transfer instrument with a local government recorder located in the jurisdiction (usually the county) where the land lies. The government indexes the instrument by the names of the grantor (transferor) and the grantee (transferee) and photographs it so any member of the public can find and examine it. In general, if the transferor then purports to transfer the property to someone else who does not know he already transferred it to someone else, and the first transfer was not recorded, that transfer is void with respect to the second transferee and the second transferee owns the land.

Under this system, to determine who has title, one must:

• Examine the indexes in the recorders' offices, pursuant to various rules established by state legislatures and courts
• Scrutinize the recorded instruments
• Determine how they affect the title under applicable law. The final arbiters of title matters are the courts, which make decisions in suits brought by disagreeing parties. Initially, the person who wanted to understand the title would hire an abstractor to search for the documents affecting title to the land in question, and an attorney to opine on their meaning under the law; this is still normal in some places. However, in most of the U.S., people have found this procedure cumbersome and inefficient. If the abstractor or attorney makes a substantial error, he compensates his client only to the limit of his financial responsibility (including his liability insurance). Furthermore, if the error was not due to his negligence, the abstractor or attorney may not compensate the client at all. The opinions given by attorneys as to each title are not uniform, so the client must spend time analyzing each one and has a risk of misunderstanding it.

Title insurers use this recording system to produce an insurance policy for any purchaser or mortgagee of land. Title insurers search the records of the recorders' offices and make a determination of who owns the title and to what interests it is subject. The policies are fairly uniform (a fact that greatly pleases lenders and others in the real estate business) and the insurers carry, at a minimum, the financial reserves required by insurance regulation to compensate their insureds for valid claims they make under the policies. This is especially important in large commercial real estate transactions where many millions of dollars are invested assuming real estate titles are valid. Under such a policy, the insurer also pays for the defense of its insured in legal contests. In contrast, abstractors and attorneys have no such obligation.

Advocates of this system of property recording argue that a property system which is inherently contingent provides a stronger guarantee of private property rights over the long run than a registration system which provides assurance of one's rights to private property.

3. Types of policies

Standardized forms of title insurance exist for owners and lenders. The lender's policies include a form specifically for construction loans, though this is rarely used today.

3.1 Owner's policy

The owner's policy assures a purchaser that the title to the property is vested in that purchaser and that it is free from all defects, liens and encumbrances except those listed as exceptions in the policy or are excluded from the scope of the policy's coverage. It also covers losses and damages suffered if the title is unmarketable The policy also provides coverage for loss if there is no right of access to the land. Although these are the basic coverages, expanded forms of residential owner's policies exist that cover additional items of loss.

 

The liability limit of the owner's policy is typically the purchase price paid for the property. As with other types of insurance, coverages can also be added or deleted with an endorsement. There are many forms of standard endorsements to cover a variety of common issues. The premium for the policy may be paid by the seller or buyer as the parties agree. Usually a custom in a particular state or county on this matter reflects in most local real estate contracts. One should inquire about the cost of title insurance before signing a real estate contract that provides that he pay for title charges. A real estate attorney, broker, escrow officer (in the western states), or loan officer can provide detailed information as to the price of title search and insurance before the real estate contract is signed. Title insurance coverage lasts as long as the insured retains an interest in the land insured and typically no additional premium is paid after the policy is issued.

3.2 Lender's policy

This is sometimes called a loan policy and it is issued only to mortgage lenders. Generally speaking, it follows the assignment of the mortgage loan, meaning that the policy benefits the purchaser of the loan if the loan is sold. For this reason, these policies greatly facilitate the sale of mortgages into the secondary market. That market is made up of high volume purchasers such as Fannie Mae and the Federal Home Loan Mortgage Corporation as well as private institutions.

The American Land Title Association ("ALTA") forms are almost universally used in the country though they have been modified in some states. In general, the basic elements of insurance they provide to the lender cover losses from the following matters:

1. The title to the property on which the mortgage is being made is either
• Not in the mortgage loan borrower,
• Subject to defects, liens or encumbrances, or
• Unmarketable.
2. There is no right of access to the land.
3. The lien created by the mortgage:
• is invalid or unenforceable,
• is not prior to any other lien existing on the property on the date the policy is written, or
• is subject to mechanic's liens under certain circumstances.

As with all of the ALTA forms, the policy also covers the cost of defending insured matters against attack.

Elements 1 and 2 are important to the lender because they cover its expectations of the title it will receive if it must foreclose its mortgage. Element 3 covers matters that will interfere with its foreclosure.

Of course, all of the policies except or exclude certain matters and are subject to various conditions.

There are also ALTA mortgage policies covering single or one-to-four family housing mortgages. These cover the elements of loss listed above plus others. Examples of the other coverages are loss from forged releases of the mortgage and loss resulting from encroachments of improvements on adjoining land onto the mortgaged property when the improvements are constructed after the loan is made.

3.3 Construction loan policy

In many states, separate policies exist for construction loans. Title insurance for construction loans require a Date Down endorsement that recognizes that the insured amount for the property has increased due to construction funds that have been vested into the property.

4. Land title associations and standardized policies

In the United States, the American Land Title Association (ALTA) is a national trade association of title insurance underwriters and title insurance agents. ALTA has created standard forms of title insurance policy "jackets" (standard terms and conditions) for Owners, Lenders and Construction Loan policies. ALTA forms are used in most, but not all, U.S. states. ALTA also offers special endorsement forms for the various policies; endorsements amend and typically broaden the coverage given under a basic title insurance policy. ALTA does not issue title insurance; it provides standardized policy and endorsement forms that most title insurers issue.

Some states, including Texas and New York, may mandate the use of forms of title insurance policy jackets and endorsements approved by the state insurance commissioner for properties located in those jurisdictions, but these forms are usually similar or identical to ALTA forms.

5. Comparison with other forms of insurance

Title insurance differs in several respects from other types of insurance. Where most insurance is a contract where the insurer indemnifies or guarantees another party against a possible specific type of loss (such as an accident or death) at a future date, title insurance generally insures against losses caused by title problems that have their source in past events. This often results in the curing of title defects or the elimination of adverse interests from the title before a transaction takes place. Title insurance companies attempt to achieve this by searching public records to develop and document the chain of title and to detect known claims against or defects in the title to the subject property. If liens or encumbrances are found, the insurer may require that steps be taken to eliminate them (for example, obtaining a release of an old mortgage or deed of trust that has been paid off, or requiring the payoff) before issuing the title policy. In the alternative, it may except from the policy's coverage those items not eliminated. Title plants are sometimes maintained to index the public records geographically, with the goal of increasing searching efficiency and reducing claims.

 

 

The explanation above discloses another difference between title insurance and other types: title insurance premiums are not principally calculated on the basis of actuarial science, as is true in most other types of insurance. Instead of correlating the probability of losses with their projected costs, title insurance seeks to eliminate the source of the losses through the use of the recording system and other underwriting practices. As a result, a relatively small fraction of title insurance premiums are used to pay insured losses. The great majority of the premiums is used to finance the title research on each piece of property and to maintain the title plants used to efficiently do that research. There is significant social utility in this approach as the result conforms with the expectations of most property purchasers and mortgage lenders. Generally, they want the real estate they purchased or lent money on to have the title condition they expected when they entered the transaction, rather than money compensation and litigation over unexpected defects. This is not to say that title insurers take no actuarial risks. There are several matters that can affect the title to land that are not disclosed by the recording system but that are covered by the policies. Some examples are deeds executed by minors or mentally incompetent persons, forged instruments (in some cases), corporate instruments executed without the proper corporate authority and errors in the public records. However, historically, these problems have not amounted to a high percentage of the losses paid by the insurers. A more significant percentage of losses paid by the insurers are the result of errors and omissions in the title examining process itself.

6. Homeowner's right to choose a title insurance company

In an April 2007 United States Government Accountability Office (GAO) Report on Title Insurance, the GAO recommended that state and federal legislators and regulators improve consumers ability to shop for title insurance based on price, encourage price competition, and ensure consumers are paying reasonable prices for title insurance. 

A federal law called the Real Estate Settlement Procedures Act (RESPA) entitles the individual homeowner to choose a title insurance company when purchasing or refinancing residential property. Typically, homeowners don't make this decision for themselves, instead relying on their bank's or attorney's choice; however, the homeowner retains the right. RESPA makes it unlawful for any bank, broker or attorney to mandate that a particular title insurance company be used. Doing so is a gross violation of federal law and any person or business doing so can be heavily fined or lose its license.

Section 9 of RESPA prohibits a seller from requiring the home buyer to use a particular title insurance company, either directly or indirectly, as a condition of sale. Buyers may sue a seller who violates this provision for an amount equal to three times all charges made for the title insurance.

The only exception to this rule applies to commercial real estate transactions, which is not within the parameters of RESPA.

The new GFE, or Good Faith Estimate, is the latest step taken by HUD to protect and assist consumers. In the past, lenders had provided potential borrowers with Good Faith Estimates. However, there are major differences between what borrowers have historically received and what they will receive going forward under the new HUD regulation. Four major changes stand out:

1. Lenders are now required to issue the GFE

If a loan originator does not provide a GFE within 3 business days of receiving a completed loan application, they are in violation of Section 5 of RESPA. HUD provides the specific criteria for what constitutes a complete loan application:

• Borrower's Name
• Borrower's Monthly Income
• Borrower's SSN (To obtain a credit report)
• Property Address
• Estimate Value of the Property
• Loan Amount
• Anything Else the Lender Deems Necessary

2. The new GFE is standardized

All lenders must provide consumers with the exact same document. Loan charges, third-party fees, and other costs must be displayed uniformly. Previously, lenders were not uniform in their interpretations of what fees should be included on the GFE and where such fees should be disclosed.

3. The new GFE encourages consumers to shop

Since lenders are now required to issue a standardized GFE in a specific time frame, consumers are provided an opportunity to compare lenders and their products. Further, HUD states that prior to the issuance of a GFE, lenders can only charge potential borrowers a fee to cover the expense of a credit report. The relative low cost of credit reports ($15 - $30) results in consumers' ability to comparison shop many lenders at a minimal cost.

4. Lenders are accountable for their quotes

Each section in the GFE now directly corresponds to a section of the HUD-1. The HUD-1 is a standardized document that lists every expense involved in a real estate or refinance transaction and is presented to the borrower during the closing process. Each section in the new GFE is now designated a tolerance level. There are three different tolerance levels:

a. 0% Tolerance. If at the closing, any item in the 0% Tolerance category is higher on the corresponding section of the HUD-1 compared to the original GFE, the lender is responsible to cover the difference.

b. 10% Tolerance. Unlike the 0% Tolerance category, these items are not compared individually to their corresponding section in the HUD-1. Instead, all items in the “10% Tolerance” are aggregated on the GFE and compared to the aggregated corresponding items on the HUD-1. In the event that the HUD-1 has a total more than 10% higher than the total on the GFE, the lender is responsible for any expense in excess of the 10% increase. This means that any one item in the 10% tolerance category can increase more than 10% from the GFE to the HUD-1 without a penalty to the lender, as long as the sum of all the items does not increase more than 10%.

c. No Tolerance. A few sections of the new GFE fall into the “No Tolerance” section. These quotes can change with no penalty to the lender.

Again, depending on the state, region, and vendor, homeowners can save substantial money by shopping around for title insurance. In light of the changes made by RESPA and those to the GFE, notable consumer and business publications have featured articles about the benefits of shopping around for title insurance, such as The Wall Street Journal, Kiplinger's Personal Finance, Forbes.com, and The New York Times.

7. Affiliated business arrangements

Sometimes, several businesses that offer settlement services are owned or controlled by a common corporate parent. These businesses are known as "affiliates," while the relationship is called an "Affiliated Business Arrangement" or "ABA" for short.

When a lender, real estate broker, or other participant refers his homebuyer to an affiliate for a settlement service (such as when a real estate broker refers his homebuyer to a mortgage broker affiliate), the law requires the referring party to provide an Affiliated Business Arrangement Disclosure. This disclosure informs homebuyers they are not required to use the affiliate and are free to shop for other providers.

Despite advances in technology that allow homebuyers to shop for title services, many homebuyers remain unaware that they may select their own title insurance or settlement company.

A recent survey from the Ohio Association of Independent Title Agents (OAITA), conducted from 2009 through 2010, showed when homebuyers are made fully aware of ABAs, they become uncomfortable and prefer a title company or title agent to be a third party (i.e., independent) to the transaction.

While 77% of respondents did not independently select their settlement company, when made fully aware of the ABA relationships 50% of respondents said they prefer a title company that does not share profits with a referral source compared to 6% of respondents saying they prefer a title agent that shares profits with a referral source. Further, 58% of respondents said they believe that ABAs are a conflict of interest.

The OAITA stands in stark contrast to two Harris Interactive surveys used by the Real Estate Services Providers Council in a January 2011 meeting with Federal Reserve staff to claim that homebuyers were more satisfied with the ABA settlement service providers.

• A 2002 study used by the proponents revealed that 64% of homebuyers who used “one-stop shopping” programs had a better overall experience with their home purchase transaction.

• A 2008 study revealed that homebuyers who used “one-stop shopping” in their latest real estate transaction were more satisfied with their home buying experience compared to those who used services of multiple providers.

Organizations such as the National Association of Independent Land Title Agents seek to restore transparency and credibility to the land title process and to preserve an objective and impartial role at the closing table to improve the consumer experience, by addressing the proliferation of controlled business arrangements and eliminating conflicts of interest between title agents and their referral sources, as well as between all real estate settlement service providers and their sources of business.

7. Cost of title insurance

The cost of title insurance has two components: premium charges and service fees.

7.1 Premium charges

Some states do not regulate the premiums for title insurance. Examples are Illinois, Georgia and Massachusetts. However, the vast majority of state governments do individually regulate the insurance premiums charged for properties located in the state. The regulation runs from requiring the filing of rates by the insurers (and requiring their use while they are in effect) to promulgating the rates that will be used by all title insurers within the states. An example of the latter is Texas, where rates are set after comprehensive hearings each year. In most states, there is an approval requirement. This varies from rates being deemed approved if no complaints are filed within a specified period of time after filing, to the requirement of approval by the state's insurance regulator before use of the rates is allowed. The rates may include discounts if title insurance is ordered within a specified time after the last policy issued or if the mortgage being insured is a refinance of an earlier mortgage. In the states employing any of these regulations, it is illegal for title insurance companies to charge a higher or lower rate than the regulated rate.

For example: In Pennsylvania there are two rates, basic rate and reissue rate. The basic rate would apply if it has been more than ten years since the last policy was issued. Less than ten years, the reissue rate applies. The reissue rate offers a discount of approximately ten percent off of the basic rate. If the transaction is a refinance, the savings can be as much as thirty percent off of the reissue rate. These rates and applicable discounts are filed with and approved by the Pennsylvania Insurance commission.

7.2 Service fees

In some states, the regulated premium charge does not include part of the underwriting costs necessary for the process. In those states, title insurers may also charge search or abstracting fees for searching the public records, or examination fees to compensate them for the title examination. These fees are usually not regulated and in those cases may sometimes be negotiated. In some states, regulation requires that the title insurer base its policy on the opinion of an attorney. The attorney's fees are not regulated. They are also not part of the title insurance premium, though the title insurer may include those fees within its invoice as a convenience to the attorney rendering the opinion. Similarly, fees for closing a sale or mortgage transaction are not regulated in most states though the charge for closing may appear in the invoice disclosing the total charges for the transaction.

Posted in: Residential