By Jason Kane, Esq.

When buying a home through normal real estate procedures, mortgage lenders usually require that you purchase homeowner's insurance to protect your home (and the bank's asset) against fire, theft, and wind damage. If you live near a body of water or in a flood zone, your lender may require flood insurance, too.

Although required by lenders, homeowners insurance makes good sense since your home is usually your most important asset. Losing your home is a catastrophic event - one that many of us don't even want to contemplate.

As a real estate investor, you also want to protect your investment: whether you're buying a distressed property in order to "flip" it or are purchasing a property you'll then rent out, you need insurance to protect your asset.

During my career of performing thousands of real estate closings some of the worst advice I've ever heard given is not to buy title insurance. Some say a thorough title search is all that's needed. Others think title insurance is one of those overpriced "nice to have" options foisted on consumers by hungry insurance agencies. And, some investors mistakenly think that title insurance can't be purchased for foreclosed properties - which isn't true at all.

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Foregoing title insurance when buying your home is a risky choice - a risk that's significantly compounded when it comes to buying foreclosed properties.

What is title insurance?

Like other insurances, buying an owner's policy of title insurance is a form of protection against catastrophic events. Title insurance differs from fire or flood insurance in two ways:

1. Flood or fire insurance protects you going forward from the day you purchase the policy. Title insurance, on the other hand, protects you from the day you take title on the property against any losses arising from events that occurred prior to the date of the policy. In other words, your coverage ends on the day you purchase the title insurance policy and extends backward in time.

2. Unlike other insurances where you make quarterly, semi-annual, or annual payments for the life of the policy, title insurance is a one-time investment. You pay for it when closing on the property - and then forget about it until you need it.

Just as homeowners insurance protects your home against catastrophic loss going forward, title insurance protects your investment against loss in the form of undisclosed liens, lawful claims on the property, and fraud that may have occurred prior to you owning the property - and that didn't show up in a title search.

Why investors should seriously consider title insurance

"But can I purchase title insurance on a foreclosed property?" you may be asking. The answer is yes, in some cases you can. Unfortunately, you cannot purchase title insurance for properties bought at auction (which is one reason why buying at auction is incredibly risky). However, title insurance is available when buying foreclosed properties directly from the seller, a real estate agent acting on the seller's behalf, or the bank.

With regards to title, investing in bank-owned properties (REOs) is less risky than buying at auction or from the seller because the bank, in an effort to recoup its losses, will bid on the property at auction, wipe out other lien holders, then pay the balance of outstanding property taxes to secure the property's clear title.

Having absorbed these costs, the bank generally adds them to the asking price and will sell the property with clear title. And, buying REO properties means you have the opportunity to purchase title insurance.

Why do I recommend investors purchase title insurance when available for foreclosed properties?

1. Title insurance protects you from undisclosed liens.

   One of the biggest risks that investors run into is finding out the equity they thought they had when buying a property in foreclosure no longer exists due to liens being discovered once the property is purchased.

   A title search by a competent attorney will reveal if the party foreclosing on the property is a first lien holder or a subordinate lien holder. If the mortgage being foreclosed on is a first mortgage and the property is bought at a foreclosure sale, then most other liens on the title could be wiped out. Exceptions to this action include unpaid municipal taxes, IRS tax liens, and in some instances condominium association fees.

   When conducting a title search, you or your real estate attorney will want to review the title report, check with the municipality prior to bidding on the property to see if all taxes are paid to date. If the property is a condominium, call the condo association to determine if fees are due.

   In addition to first and second mortgages, other liens include state and federal tax liens, child support liens, liens from credit card companies, unpaid contractors, executions, and a host of other individuals and companies. These types of liens will generally show up in a thorough title search.

   Once you purchase the property, you are responsible for any and all liens on the property - known and not known. Hence, a property you bought at a foreclosure sale for $150K that has a fair market value of $175K can have $45K in undisclosed liens - quickly wiping out your profit and your bank account if you don't own title insurance.

2. Title insurance protects you from fraud.

   Fraud is a major issue in the real estate industry. With title insurance, your investment is protected 100% should you learn the property was sold to you via fraudulent methods.

   For example, an unscrupulous Seller with a $100,000 second mortgage may want to "hide" this mortgage to make the foreclosed property appear more desirable to potential bidders. To do so, all the Seller has to do is go to the local Registry of Deeds where the property is located and file a mortgage discharge form. Basically he would forge the signature of his current Lender on a document that proclaims to state that the second mortgage has been paid off. When you or your real estate attorney then conduct a title search, you have no reason to believe a second mortgage exists because it's been discharged.

   Or, let's say an elderly woman ends up in a nursing home and can no longer conduct her own financial affairs. Her son, acting as her agent without her knowledge, forges her name on the real estate documents and sells the foreclosed property to you. A few months down the road, the sheriff comes knocking at your door saying, "You were sold this house under fraudulent pretenses. It doesn't belong to you." Gulp.

3. Title insurance reimburses you for the amount of your loss.

   Whether you learn title to your property is fraudulent or someone later lays claim to your property, title insurance ensures you're reimbursed for the amount of your loss and for your legal and/or attorney fees.

   Investors buying distressed properties will also want to consider adding a special rider to title insurance policies that takes into account inflation. Let's say you purchase a property for $100K and due to inflation and other factors, it's now worth $150K. However, due to a fraudulent situation, a former owner lays claim to your property. The special rider protects your asset at its current value - $150K - versus its purchase price.

A sound investment that protects your assets

The hypothetical situations listed above are just a few of the innumerable ways you could find yourself in serious jeopardy of losing your investment - and the shirt off your back - because of a title defect. (Trust me, I can come up with dozens more.) Title insurance is an invaluable, inexpensive, one-time investment that provides you with peace of mind the entire time you own the property.

Don't let title insurance be a spur of the moment decision when closing on a property. Do your homework: in Massachusetts it pays to shop around for real estate attorneys whose only specialty is title searches, closings, and insurance products as they can offer you the best expertise and options.

Title insurance costs do vary but in general, expect to pay roughly $3.50 per $1,000 of purchase price. For a $300K property, that's a $1,000 policy - a sound investment no matter how you slice it.

Jason Kane is a real estate attorney and president of Kane Title Services, a title company located in Plainville, MA that offers title examinations, title insurance products, and title closings. He can be reached at jkane@kanetitle.com or at 508-809-6580.

« Strategies for Determining Property Value

January 2007

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