Title insurance companies will guarantee that you have good title to your real estate, subject to no other claims.
If someone else claims to own some interest in the property, the insurance company will either pay the legal fees to contest that claim, or it will pay off the claimant. It works the same way with liens. If there is title insurance and the IRS says it has a $40,000 lien on your property because of past due taxes of the former owner, the title insurance company will pay the $40,000 to obtain a release of the lien.
All real estate lenders require title insurance as a condition of funding their loans. You actually buy the policy at closing on the real estate. The buyer pays the one-time premium as part of the closing costs. What most buyers do not realize is that their equity in the property is not covered by the lender’s title insurance. In other words, the buyer must request, and pay the premium for, owner’s title insurance.
To illustrate this, suppose Karen buys a postforeclosure property for $80,000. She pays $16,000 down, and finances $64,000 with 1st National. She pays for the lender’s title insurance, but does not obtain owner’s coverage. Three months after closing, the IRS reveals that it had a lien on the property for $100,000, and the foreclosure did not erase its lien. It wants to seize the property and sell it because it thinks it can find a buyer for $100,000. The title insurance company will pay 1st National $64,000, the full amount of the claim. Karen has no title insurance of her own. Karen will simply lose her $16,000 because the IRS will be able to seize the property and pay her nothing.
It does you no good to secure title insurance at closing if the policy says it will not insure against certain things, such as a $100,000 IRS lien. Most foreclosure sellers will not give you any promises or warranties that they have good title to sell to you. The most they will promise is that they, personally, have done nothing to mess up the title. They advise you of this by saying they will transfer title by special warranty deed. The typical deed in most normal circumstances is a general warranty deed. You are supposed to know that a special warranty deed means the lender is not making any promises.
If you are the winning bidder at auction, or if you sign a contract to buy a postforeclosure property, you may not be able to cancel if you find out there is a $100,000 IRS lien, to use the previous example. Clearly, an early warning system is necessary. That early warning system is a title commitment.
The title commitment says that the title insurance company will issue a policy insuring your title if certain specifically described issues, such as a $100,000 IRS lien, are cleared up before closing. This gives you a sneak peak at the title defects if there are any. You can then make an informed decision about whether to proceed to auction or sign a contract at that point.