Title insurance: What is it and who needs it?

If you’ve ever bought land or a home, you likely encountered the term “title insurance”—one of many potential mystery fees frequently paid at real-estate closing. But this fee has little in common with service charges and other vague-but-sort of-legitimate-sounding expenses seemingly designed to pad the bill. Instead, the title-insurance bill is an investment in peace of mind.

To understand why, let’s start with everyone’s favorite topic—definitions. “Title” means ownership, which can be further divided into lesser forms of ownership such as a lease. Title is the right, for example, to sell, lease, or build a house on the land.

But it’s not enough to say that you own the land; you must prove it through evidence. That’s largely done through legal documents such as “deeds” and “ground leases,” each of which memorialize title transfers from one person to another. Each deed or lease is signed, notarized, and then given to the Recorder’s Office, which makes the document publicly accessible. Giving these documents to the Recorder’s Office is known as “recording.”

Confirming ownership is one of the key tasks during a real-estate transaction. And the title-insurance process is the main way of doing so. It involves the title-insurance company scouring the property’s ownership history to figure out whether the seller owns the land, whether anyone else shares ownership with the seller, and whether the property has any other title defects like a lien or levy. Along the way, the title company will comb through a plethora of public records, including prior deeds, wills, trusts, divorce decrees, court judgments, tax records, and even bankruptcy filings.

At the conclusion of this research, the title company will issue what’s known as a preliminary title report. Hopefully the PTR shows that the owner has “clear” title—meaning (among other things) that there are no liens, levies, encroachments, or disputes that the seller is the only property owner. But if the research turns up trouble spots, which happens about a third of the time nationally, then the seller and buyer can decide whether they want to fix the problems, cancel the deal, or renegotiate.

If the parties move forward with the deal, then the buyer usually purchases title insurance from the title company, payable at closing. This insurance is a one-time fee for the title company’s promise to protect the buyer if anyone later challenges the buyer’s ownership of the property.

At this point, you may be wondering why a buyer should bother with title insurance if the PTR shows that the seller has clear title. The reason is that title problems have a way of hiding for years or decades. And when they do surface, it will translate into not only an expensive legal bill but also potentially the loss of the property and all of the money you’ve previously paid.

How large is the risk that title problems will emerge years or decades after a PTR seemingly gave the property’s title a clean bill of health? Nationwide, about 5 percent of title-insurance policies pay out, so about 1-in-20 times the title was not as clean as the PTR indicated, usually because of fraud, omitted heirs, undiscovered liens, or errors in the public record.

Now that we’ve discussed why title insurance is frequently a good idea, let’s talk about what kind of problems a PTR will reveal. In the worst cases, it will expose criminal behavior—someone knowingly trying to sell property that they don’t own at all. Sadly, I see this every year or two.

More common is that the PTR shows that the seller doesn’t own as much of the property as they think. For example, they may co-own the property with an off-island sibling who hasn’t been here in years but who nonetheless must sign off on the deal too, notwithstanding that the on-island sibling largely acts like the landowner day to day. Or the seller may not officially own the property yet because they took possession of the land when their parents passed away but never formally transferred title to the property from the parents to themselves through a process known as probate (which is a court-supervised process for gathering a dead person’s stuff, paying off their debts, and then transferring what remains to the heirs).

Other times, the PTR unearths ancient problems. Perhaps, for instance, a previous owner bought land from a single guy, not knowing that the land was marital property, so the guy’s ex-wife needed to consent to the deal too. Or the seller may have inherited the property through a will that later turned out to be void because it was canceled by a later-created will that left the property to someone else.

The PTR can also reveal debts and other financial obligations that may need to be paid from the proceeds of the property sale. The most common debt is a mortgage. If one exists, you’ll want to check if the sale price is higher than the balance due on the mortgage. If not, the buyer will be stuck with the unpaid balance after the sale. Meanwhile, the most common liens include tax liens, child-support liens, and mechanic’s liens. These liens stick to the property like glue; transferring title to someone else does not get rid of them. So, a buyer will want the seller to solve them before the property changes hands.

To sum up: If you plan to buy property, get a PTR. It will surface most title problems (assuming there are any). And if you want peace of mind, buy title insurance. It’s a one-time expense to know you’re protected if the PTR missed something.

This column is for informational purposes only and is not intended to be taken as legal advice. For your specific case, consult a lawyer.