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Long ago, if you purchased a home, the question of ownership was rarely a problem. Most people assumed that the property belonged to the person selling it. Once escrow completed, the title of the house would be transferred to the new owner.
Today, the issue of ownership if murkier. The person selling a house may not own it - at least, not entirely. This is the reason title insurance exists: to protect the homebuyer and mortgage lender from purchasing a property to which other parties have a legal claim. This article will describe how title insurance works, and explain the reason it is necessary. We'll also take a look at short sales, foreclosures, and other distressed homes for sale, in the context of identifying ownership.
How Title Insurance Works
Many companies specialize in underwriting insurance policies that guarantee the property you purchase is owned by the person selling it. These are title insurance companies. During the escrow process, they investigate the ownership of homes for sale to make sure secondary parties have no legal claim. If, following the transfer of title, a future claim of ownership proves valid, the insurance company agrees to cover the associated costs.
The Reason Title Insurance Is Necessary
Title insurance was once considered unimportant. As mentioned earlier, most people assumed the party selling a property actually owned it. Problems were usually limited to small details, such as whether a next-door neighbor had built part of his tool shed on the listed property. The last several years - culminating with the recent slowdown in the residential real estate market - have changed this. A high percentage of listed properties are sold where second parties have legal claims on ownership.
For example, consider a person who owns his house. He might take out a second mortgage to finance a major home improvement project. The lender would have a legal claim on the property. If the homeowner fails to pay the second mortgage, this claim would create a title problem.
The seller may also have a line of credit using the house as collateral; he might owe back taxes for which a lien has been placed on the property; or, he may have neglected to pay a contractor, who placed a lien on the house for lack of payment. Another problem that has become more prevalent over the past few years is that many homeowners are "upside down" in their mortgages. That is, the amounts owed on their mortgage loans exceed the appraised values of the properties.
These and other circumstances have created myriad title problems. Two examples are short sales and foreclosures.
Short Sales And Foreclosures
A short sale occurs when a seller is "upside down," and the lender agrees to sell the house for a lesser amount than owed. For example, suppose a homeowner buys a $300,000 a home with a 10 percent down payment. The amount owed on the mortgage is $270,000. Now suppose the appraised value of the property falls to $250,000.
In this case, the seller must give the lender $20,000 in addition to the sale amount ($250,000) in order to pay off the mortgage loan. On the other hand, the lender may agree to sell the home for $250,000, and write off the loss. This is a short sale. The problem is that such sales make title searches problematic, especially when other ownership claims, such as tax liens, surface.
With a foreclosure, the lender assumes ownership of a property due to the homeowner's failure to make timely mortgage payments. Title often becomes unclear, especially when the lender seeks to purge distressed properties from their portfolio. Making matters worse, the recent real estate slowdown has created additional questions regarding ownership of these properties. For example, in 2010, JP Morgan and Bank of America were forced to stop all of their foreclosure transactions when title questions surfaced.
Title insurance is costly, but necessary. For this reason, most mortgage lenders require borrowers to have it before they will agree to extend a loan.
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