When purchasing a Seller Financed or other real estate secured note, whether performing or non-performing, part of the due diligence should be obtaining a Lender’s Title Insurance Policy. But why? And what is Title Insurance anyway?
Title insurance is a form of indemnity insurance that protects against financial loss sustained from defects in a title to a property. The most common type of title insurance is lender’s title insurance, to protect the lender. The other type is owner’s title insurance, which protects the buyer’s equity in the property. The one-time fee paid for title insurance covers administrative fees for deep searches of title data to protect against claims for past occurrences.
Clear title is necessary for any real estate transaction, especially note purchases. Title companies must do a search on every title in order to check for claims or liens of any kind against them before the insurance can be issued.
A title search is an examination of public records to determine and confirm a property’s legal ownership and to find out whether there are any claims on the property. Erroneous surveys and unresolved building code violations are two examples of blemishes that can make the title “dirty” or “clouded.”
Title insurance protects both lenders and buyers against loss or damage occurring from liens, encumbrances, or defects in the title or actual ownership of a property. Common claims filed against a title are back taxes, liens (from mortgage loans, home equity lines of credit and easements), and conflicting wills. Unlike traditional insurance, which protects against future events, title insurance protects against claims for past occurrences.
A title insurance policy usually covers the following hazards:ownership by another party, incorrect signatures on documents (as well as forgery and fraud), flawed records, restrictive covenants (terms that reduce value or enjoyment such as unrecorded easements) and encumbrances or judgments against property (such as outstanding lawsuits and liens).
As mentioned, there are two types of title insurance: lender’s title insurance and owner’s title insurance. Most lenders require the borrower to purchase a lender’s title insurance policy to protect the lender in the event the seller was not legally able to transfer the title of ownership rights. A lender’s policy only protects the lender against loss. An issued policy signifies the completion of a title search, offering some assurance to the note buyer (lender). However,in some real estate transactions no one obtains title insurance or they only get owners title insurance, especially in Seller Financed Note transactions, which causes us as note buyers to get it for ourselves. Getting only a title search is not a substitute when purchasing a note since title searches are not infallible and the note buyer (lender) remains at risk of financial loss.
There are four major U.S. title insurance underwriters: Fidelity National Financial, First American Title Insurance Company, Old Republic National Title Insurance Company, and Stewart Title Guaranty Company. There are also regional title insurance companies from which to choose. The cost of title insurance can range from 1% to 3% of the balance of the note (loan), depending on the county and state that the property is located, the insurance provider chosen and the size of the note (loan).
Skipping this part of due diligence and not getting title insurance exposes the note buyer (lender) to significant risk in the event a title defect is present. Consider a simple example of note buyer finding the note of their dreams only to find, after closing, an unpaid mechanics lien. Without title insurance, the financial burden of this claim may rest solely with the note buyer (trying to get the payor/borrower to take responsibility is not always possible). Under the same scenario with title insurance, the coverage protects the note buyer for as long as they own or have an interest in the note. In addition, the lender’s title insurance covers the note buyer (lender) from other unrecorded liens, unrecorded access rights and other defects. In case of a borrower’s default, if there are any issues with the property’s title, a lender would be covered up to the amount of the note (mortgage).
Note investors should make sure that a property does not have a “clouded” title before proceeding with any note purchase. Seller Financed Notes, whether performing or non-performing, may inherently have a number of outstanding issues. Note investors should always consider purchasing lender’s title insurance to protect themselves against unforeseen claims against the title.
This information is provided as a courtesy and does not cover the Title Commitment in its entirety. Please contact legal counsel for any legal advice. Next month I will go over the nuts and bolts of title insurance. Hope this helps! Be kind, keep safe and stay healthy. Remember success demands action, keep on marketing, it’s going to work! TWITA! (That’s What I’m Talkin’ About!)
Jeff Armstrong of Armstrong Capital has been a note investor and broker specializing in the performing seller financed note industry since 1991. For more updated and current information on how he can help you with your note business, note investments, note appraisals or to request pricing options on a note visit www.armstrongcapital.com to email him and subscribe to Jeff’s Weekly Training & Tips Newsletter.