Title Insurance 101 – How Do You Determine the Amount of Policy?
You would think it is pretty easy to figure out how much title insurance to buy. But it’s not. That’s because the Amount of the Policy can be determined by several different factors, which need to be considered when you are purchasing the policy.
First of all, let’s talk about Owner’s Policies. Generally speaking, the Amount of Insurance for an Owner’s policy will be the purchase price paid for the property. For example, a purchaser pays $100,000 for an existing home that he is buying from the seller and that will be the Amount of Policy. But, what if the purchaser wants to make some significant improvements to that property? If the purchaser intends to make $50,000 in improvements to the property, then he can purchase a policy in the amount of $150,000, representing the original purchase price plus the cost of immediately contemplated improvements.
What if the purchaser buys the property for $100,000, but it is the bottom of the market, and he believes the property will appreciate significantly within the next five years? Then it is possible to ask the title company for a policy in an amount greater than the original purchase price, generally up to an additional 50% of the value. This type of coverage is generally achieved through the issuance of an inflation endorsement where for an additional premium, the title company agrees to increase the Amount of Insurance under the policy ten percent per year for the next five years, not to exceed 150% of the original Amount of Insurance. This type of coverage is not universally available, so be sure to ask your title company about it if you are interested.
What if you want to save money and purchase a title policy for less than the purchase price of the property, figuring you would be willing to assume a small risk of loss? Most state regulations prohibit title companies from knowingly issuing a policy for less than the purchase price, since the premiums and loss reserves are based on the fair market value or purchase price of the property to be insured. So this is generally not an option.
What if you inherited the property, or got in as part of a divorce and you want to make sure the title is properly vested in you? The title company will require you to get an appraisal done by a certified appraiser approved by the title company, and will use the appraised value as the basis for the Amount of Insurance. If the property was previously covered by a title insurance policy, then you might be able to step into the shoes of the insured under the old original policy, but you need to consider the fact that property values may have increased since the title policy was issued and that you might want to increase and down-date the coverage. This is best done by the issuance of a new policy in the appraised amount. You might be eligible for some kind of discount on your premium, but this depends on local title insurance regulations, so be sure to check with your title company on that.
What if you are leasing some commercial property for 10 years, and your rental payments will be $40,000 per year. If you want to get a title policy to cover your investment in the lease, purchasing a title policy for the current purchase value of the property will generally not be equal to the total of your lease payments. For example, say the property is worth $200,000 at the time of your lease. But if your rent is $40,000 per year for 10 years, your aggregate rental payments will be at least $400,000, and could be more if there are built-in cost of living increases or percentage rents built into your lease. This is one of the times you will need to talk to the title company and negotiate with them a fair Amount of Insurance, recognizing that the Leasehold Endorsement will provide you with additional coverages that are very useful in the event you are evicted by reason of a title defect.
Now, let’s talk about Loan Policies. Again, generally speaking, a loan policy will be issued in the amount of the lien of the mortgage or deed of trust that is being insured. So, assuming your purchaser above is getting a purchase money mortgage to buy the house, and assuming that the purchaser is getting a 90% loan, the mortgage will be for $90,000, and the loan title policy will be written in that amount. If the purchaser uses the same lender to finance his additional $50,000 of improvements, then the mortgage might be for $140,000, and the title policy would be written for that amount.
In commercial situations, there are different types of mortgages that may cause the amount of the mortgage to increase during the life of the loan, and this will affect how the Amount of Insurance is determined. One type of mortgage allows for future advances of principal, thereby increasing the amount of the debt and mortgage. So, let’s assume a corporation wants to mortgage its headquarters to obtain additional working capital in order to operate its business. The corporation/borrower might obtain a loan in the original principal amount of $10 million, with the option to obtain additional future advances up to $5 million, for a potential aggregate liability of $15 million. The lender would want a title policy that would protect the validity of its lien up to the full amount of the loan, or up to $15 million. The policy would be issued in the original amount of $10 million, and the lender could obtain endorsements down-dating the policy each time a future advance is made, thereby increasing the amount of insurance up to the new principal amount. These endorsements require the payment of additional premium, as well as a title search to make sure the status of the title has not changed.
Also, there may be situations where the borrower is mortgaging more than one property, and using all of his property as collateral for a blanket mortgage. In this situation, we would be dealing with a blanket mortgage (one mortgage on several properties) or several different mortgages that are cross-collateralized (a separate mortgage on each property, but which secures the debt against all the properties). For example, borrower has 5 fast-food restaurants in Los Angeles, and wants to use all of these properties as collateral for a loan in the amount of $1 million. Each property is worth only $200,000, but in the aggregate, they are worth $1 million. So the lender agrees to lend the $1 million, and can secure the loan by using either a blanket mortgage (one mortgage in the amount of $1 million against all of the properties) or can use 5 separate mortgages, each in the amount of $200,000, and all of the cross-collateralized so that each property secures the debt of the other properties. If the lender chooses to use 5 separate mortgages, he will get 5 title policies, each in the amount of $200,000, but will ask the title company to issue an aggregation endorsement, which aggregates all 5 policies, and in the event of a loss and foreclosure, allows the lender to shift coverage from one policy to another, effectively increasing the amount of coverage on the affected policy.
We will discuss construction mortgages and how owner’s and loan policies are written to deal with construction advances in a future blog.
The examples above should give you a general idea of how to determine the Amount of Insurance under an Owner’s and a Loan Policy. You should always contact your title agent if you have any questions regarding pricing for your title policy as premiums vary significantly from state to state.
As always, the opinions stated herein are solely those of the author and should not be considered a legal opinion. You should not rely on any statements in this blog as a statement of law or fact, and the opinions herein may not be used as evidence in a court of law or otherwise.