Title Insurance in Real Estate Purchases
By Matt Dickstein
Click on a heading for more articles ⇒
Title insurance in real estate purchases has always struck me as a mysterious and subtle thing. I remember reading a title policy for the first time and asking, what coverage is the buyer really getting? And how does it factor into the purchase agreement and the deal?
I’ve found over the years that buyers and sellers gloss over title. Buyers say to themselves, I’m buying title insurance so I don’t need to care about this or that title issue. Sellers say to buyers, you’re buying title insurance, so you no longer have any title risk. They’re both wrong.
In this article I will briefly explain what title really means in a real estate purchase. I will discuss (1) how to review a preliminary title report, (2) how to handle title exceptions, (3) how title fits into the purchase agreement, and (4) what a title policy really gives you. Because buyers buy title insurance, I will mostly take the buyer’s perspective.
#1 – Review the Preliminary Report.
The preliminary report (the “prelim”) is usually the first step in understanding title.
Legally, a prelim is an offer from the title company to give insurance. When you accept the prelim, a binding contract is created between you and the title company. Hence before accepting the prelim, review it, the documents listed as exceptions in Schedule B and the proposed policy itself.
Now, how do you review a prelim? Focus on the following:
*** Verify that the seller holds fee title to the property, and that your name, as the buyer, is exactly correct.
*** Be sure that the legal description of the property is identical to the description shown on any survey.
*** Review the exceptions in Schedule B for third party claims, including whether any encumbrances affect the desired use.
*** Review the exceptions in Schedule B for any restrictions on ownership, e.g. check the covenants, conditions and restrictions (CC&Rs).
*** Get copies of and read all documents referenced in Schedule B (since these will be excluded from coverage).
#2 – Handle Title Exceptions.
After reviewing the title exceptions in the prelim, your next step is clearing some of them.
First, in the purchase agreement you should require the seller to remove all monetary liens by payoff prior to closing, except: (i) financing that you will assume; (ii) current taxes constituting a lien not yet due and payable at the closing; and (iii) bonds or assessments to be allocated between the buyer and seller as of closing.
Second, negotiate with the seller for the removal, if possible, of problematic non-monetary exceptions (e.g. easements). Consider also having the title company remove all boilerplate exceptions that have no basis in reality.
A few minor title exceptions show up in all prelims. Ordinarily you don’t need to worry too much about these exceptions, namely:
*** General and special city and/or county taxes which are liens not yet payable.
*** Lien of supplemental taxes assessed pursuant to Division 1, Chapter 3.5 of the Revenue & Taxation Code.
*** Utility easements, but depending on their location and whether you intend to build over the easements.
*** CC&Rs, unless they affect or prevent your intended use of the property.
Remember that buying insurance coverage for a defect in title does not fix the defect. Although insured for, the defect remains on your property. If the defect is serious, consider walking away from the purchase no matter whether you can get title insurance, because:
*** Your policy limit is usually the purchase price for the property. The policy will not pay anything more – not the policy premium, closing costs, loan fees, repairs, improvements or anything else.
*** The insurance company might deny your claim for coverage.
*** Even if the title company gives coverage, still, if a defect ripens into an actual third party claim against the property, you will suffer delays and consequential economic loss during the litigation (which probably won’t be covered under the policy).
*** The next buyer or a future lender might decline a deal with the property based on the defect.
Conclusion: Remove all serious defects. If that is impossible, don’t buy the property no matter what coverage is available.
#3 – Title Issues in the Purchase Agreement.
Usually the seller promises marketable title in the purchase agreement, no more. From the seller’s perspective, representations and warranties about title are not necessary because the buyer should protect itself with a title policy. The seller should also beware of giving a broad representation that the property is “free and clear from all encumbrances” – as applied to land, an encumbrance is almost anything including unknown encroachments. Hence this representation is too broad.
Although sellers avoid representations about title, title is usually a condition of closing. In this respect, the parties can attach the prelim title report to the purchase agreement, and show on the prelim what title exceptions the seller will remove as a condition to closing.
#4 – The Title Policy.
My last topic is the nature of a title policy. What kind of protection are you buying? Do you even want a policy, given its cost? It seems a bit funny to talk about first things last. This discussion is very difficult, however, and I am afraid that if I started with it, no reader would survive to the end of this article. So if you’ve read this far, congratulations.
I will discuss only the CLTA Standard Coverage Policy, because that is the policy that buyers commonly purchase. [see ft.1 regarding ALTA policies]
CLTA title insurance insures title as shown in the public records. Off-record items generally are not covered. That is, CLTA insures that the liens and encumbrances listed in the prelim are the only ones of public record, as of the date of issuance of the policy. You, the insured, are buying peace of mind that the disclosed lien situation is correct, and there are no other liens of public record. Also, CLTA insures that that the seller actually owns the property – this covers problems related to fraud or forgery by the purported grantor.
With a CLTA policy, you are uninsured for liens not on the public record. Therefore, you should inspect the property for encroachments, third-party possessory rights (e.g. tenants, adverse possession), boundary line problems and anything else of interest that would not appear on the record. Also, remember that you, as a bona fide purchaser, will take free of unrecorded liens.
Parts of a CLTA Policy. The CLTA Policy is comprised of four parts:
(1) Title page, which is pre-printed and tells you the scope of your coverage and exclusions from your coverage;
(2) Schedule A, which tells you the amount of your insurance (invariably the purchase price), the premium, your name as the insured, the legal description, and any special coverage;
(3) Schedule B, which has two parts: Part I gives preprinted exceptions to coverage (including the big exception – no coverage for easements, liens and encumbrances not of public record). Part II lists the specific title exceptions from the prelim, all of which are of public record, plus a few extra exceptions that the title company tries to throw in (e.g. if the current owner acquired title as a single person but is now married, there may be an exception for any interest of the spouse).
- Here is the key to the CLTA policy – the policy covers only encumbrances of record, then the policy removes from coverage everything that the title company actually could find of record. You, the insured, are left with little except peace of mind that the disclosed lien situation is complete. You are insured that there is nothing else of record out there (that is, in the chain of title). Is the peace of mind worth the cost? I don’t know – all I know is that I buy title insurance and so do my clients.
(4) Conditions and stipulations, which are more preprinted terms. The most important term here is that the title company’s liability terminates upon conveyance of the estate held by the insured, except if the insured sells and receives back a purchase money deed of trust.
Title is a subtle topic. Don’t worry if you can’t understand it the first time, especially the CLTA policy I’m no different. In every deal when reviewing title, I go back to the basics of the CLTA policy. I always remind myself of the exact risks that I am covering through title insurance and the real world value of the insurance coverage vis-à-vis the risks.
I hope this article has helped you understand title a little better. There is a lot more to a real estate deal, however, than what I discuss here. As always, get competent legal counsel for your real estate transactions.
[ft. 1] I will give a brief introduction to an ALTA title policy. ALTA gives more coverage than CLTA because ALTA insures recorded and unrecorded defects. For this reason, ALTA costs more than CLTA. The insurance company in an ALTA policy takes the risk of inspection of the property, including encroachments, unrecorded rights of way, unrecorded leases, and the boundaries of the property based on a current survey (unless the policy has a survey exception). Lenders use ALTA to insure the priority of their liens, because lenders (unlike buyers) don’t inspect the collateral. Should you consider an ALTA policy? Maybe, if after you inspect the property, you find that there might exist an off-record claim to use the property, e.g. a driveway is being used by neighboring landowners, structures appear to encroach between boundary lines, or boundary lines are unclear.