Simply put, title insurance protects your investment. It works just like any other type of coverage by protecting you from the unexpected. In this case, it protects against unexpected claims, or liens, that occurred before you took ownership.
Prior to closing on the purchase, a real estate title company will perform a search to make sure the property is free and clear of liens. This takes place after you've provided your escrow funds to the escrow holder. Escrow funds may be held by the agency, if they provide that service.
Whatever is found during the search is then summarized and included on the policy. Generally, if something is found, the seller is asked to rectify it before the purchase is allowed to go through, but things can be missed or never turn up during the search. That is where this insurance steps in to provide protection for you. If a claim dating from prior to your purchase arises, this coverage will protect you from loss damages as a result of that claim.
This is different from almost every other type of coverage. It protects you from unseen events that occurred prior to taking it out. A policy will end on the date that it is issued and extend backward in time indefinitely. You only pay for it once. Property or life coverage, in contrast, protects you from unknown future events and is paid for annually.
Lender's Vs. Owner's Policies
Title insurance is required of just about every purchaser. If you are taking out a mortgage, the lender will require you to purchase a Lender's Policy. This policy covers the mortgage provider for the cost of the mortgage. Although the purchaser typically pays for the Lender's Policy, it does not cover the purchaser. For that, the purchaser will need separate coverage, the Owner's Policy.
These policies are indemnity policies that protect against loss. Therefore, the Lender's Policy protects against the lender's loss while an Owner's Policy protects the owner against loss. The owner will want their coverage to be for the full value of the property, not just the mortgage amount.
This all begs the question, "If a search has been done and comes up clean, why do I need this coverage?" In addition to being required by the lender, title insurance means peace of mind and protection. Without it there's a good chance any claims against the real estate will result in some kind of loss for the current owner. With it, the owner is protected against these claims. For anyone making an investment in real estate, it is a small price to pay for this peace of mind.
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