If you provide financing against real property in California, you likely have purchased title insurance.
Homeowners and lenders use title insurance to protect against defects and encumbrances on a property’s title. Common defects can include fraudulent claims of ownership, improperly recorded documents, forgery, unlawful liens, and encroachments. Title insurance is different from other insurance because while other insurance policies protect the holder against unforeseen future events, title insurance offers protection against problems with the title that may have occurred in the past.
How does title insurance work?
At the beginning of the lending due diligence process, a lender or title agent will typically open a title insurance policy with a title company. The title company will begin by performing a title search. Once the search is complete, the title company will provide the lender with a preliminary report (“prelim”) that allows them to review all liens, easements, and other covenants recorded against the property. Depending on where you are in the country, the prelim may also be referred to as a title commitment. The prelim is not an insurance policy but instead an opportunity for the lender to look at what is currently on title and to request that items be addressed prior to closing. The actual title policy will be issued after all loan documents or contracts have been signed and recorded. It will protect both the seller and the lender during a transaction.
There are two primary title policy types: Owner’s Policy and Lender’s Policy. Each title policy is issued with specific terms, conditions, and exclusions. Title insurance is codified under California Insurance Code section 104 and defined as:
“Title insurance means insuring, guaranteeing, or indemnifying owners of real or personal property or the holders of liens or encumbrances thereon or others interested therein against loss or damage suffered by reason of:
- Liens or encumbrances on, or defects in the title to said property;
- Invalidity or unenforceability of any liens or encumbrances thereon; or
- Incorrectness of searches relating to the title to real or personal property.”
This basic definition under California code seems simple enough, but unfortunately many times a title company will miss some of these items when performing a title search. While it may sound simple to run a title search, keep in mind that the title searcher has to sort through records that may be recorded by APN, property address, or by the grantor or grantee’s name. This search can combine older paper records with newer electronically recorded information, making it harder to catch everything.
The title policy will also protect the owner (lien holder) against errors or mistakes that may have been made by the searcher. Because of this risk to the title company, most title searchers provide a very thorough and detailed report, but they are only human, and mistakes still occur. This possibility is a reminder of how important a title policy is for protecting the investor or lender from unforeseen title issues.
Why do lenders obtain title policies?
The primary reason lenders obtain a title policy is to protect against liens on the property that may supersede a new lien or hamper the enforcement of their lien. Under California Civil Code section 2872, a lien is described as “a charge imposed upon specific property by which the property is made security for the performance of an act.” So, based on this definition, a lien can be any instrument issued against a property that provides a security interest to help enforce the repayment of debt. Standard liens are deeds of trust, property tax liens, or judgment liens, but you may also see mechanic’s liens, child support liens, or bail bond liens on a property’s title.
The broadness of the lien definition under California code allows attorneys to redefine the statutory definition to fit their specific issue and get it covered under the title policy. It is imperative to understand what liens and encumbrances are affecting the property to ensure they are covered under title insurance.
The term “encumbrance” is regarded to mean a lien. However, the concept of encumbrances is a much broader definition. Under the California Civil Code, the definition of an encumbrance is limited to taxes, liens, and assessments. Some court cases have redefined the definition to include any restrictions on real property that limit the use or transfer of the land. To that point, most, if not all encumbrances will be covered under a title policy.
Title insurance is crucial. If done carefully and with precision, title insurance is the most robust way for a lender to protect their capital. Carefully reviewing each prelim or title commitment with the title officer, your attorney, and/or your borrower is essential. By focusing on this step early, you can prevent small problems from becoming critical and you can protect the transaction.