Even after 30-plus years in the business, I am surprised when someone asks me the above question. But then I have to remind myself that there is no reason for a layperson to know that answer. Even sophisticated out-of-state buyers ask the question, because real estate transactions are handled differently in different states.
Let’s start with escrow. The term comes from an old French word, “escroue,” which means a scrap of paper or parchment. A dictionary definition is “a bond, deed, or other documentation kept in the custody of a third party, taking effect only when a specified condition has been fulfilled,” which is actually the best explanation. Escrow is the neutral third party that holds all the real estate transfer deeds, loan documents, and money in safekeeping. Only when the buyer and seller are in full agreement with the settlement terms, and when all documents are signed, can the escrow officer have the grant deed (to change ownership) recorded and transfer the funds to the seller. It is an excellent system and keeps the transaction at arm’s length. The escrow officer cannot act on instructions from only one of the parties; there must be full agreement to the terms or the escrow will not close.
So what is title insurance? It is exactly that — insurance. My contact at First American Title, Kallie Castro, provided a definition of title insurance: “Title insurance provides coverage for certain losses due to defects in the title that, for the most part, occurred prior to your ownership. Title insurance protects against defects such as prior fraud or forgery that might go undetected until after closing and possibly jeopardize your ownership and investment. Title insurance protects buyers against the risk of acquiring a non-marketable title from the seller.”
Lender’s title insurance (a second, separate policy) protects the interest of the mortgage lender the same way that the owner’s title insurance policy protects the owner. The owner’s policy protects the buyers for as long as they or their heirs (in certain policies) own the real estate. Castro added, “Real estate is most likely going to be the most important asset you purchase. Why would you not want to protect that?”
An owner’s title insurance policy is purchased once only, during the escrow period. A buyer is paying for research of the property title to be sure that the seller has the right to sell the property, that there are no other persons who can lay claim to the property by way of recorded documents, and that there are no outstanding liens on the property other than loans and taxes. If there are other liens found, the escrow company confirms that the liens can be paid off and how to do it. These liens might be for unpaid services or other workers’ bills. A buyer does not want to inherit the seller’s outstanding unpaid obligations.
If there are loans on the property, the escrow company will contact the lender(s) to get payoff amounts and instructions. Any amounts will be paid from the escrow proceeds so that the buyer receives the title without these encumbrances. This is called clear title. Depending on how near the close of escrow is to the property tax due date, the taxes might be paid through escrow; alternatively, a portion of the tax bill up to the day of closing will be collected from the seller and given to the buyer for payment of the next tax bill.
Sometimes all-cash buyers choose to save the money and not buy title insurance. When you are protecting against unknown liens, previous fraud or forgeries, and the potential claim of other people, it is a small price to pay to know you are protected during your entire ownership.
First American has provided me with brochures on both title and escrow. If you are interested in obtaining a copy of one or both, please contact me, and I will be happy to send them to you.