Property Ownership without Proof
It’s not common, but a person could conceivably own real property without having any proof of it. When a person has “title” he is said to have all of the documents necessary to prove ownership. Investors must be particularly concerned with getting assurances of title where they act as a lender on a property, since the quality of title affects the collateral value of the property in which they have a secured interest (like a mortgage or first trust deed).
Usually a property owner transfers his title by means of a legal document called a “deed,” which must be in writing and meet other local requirements. Title can be transferred, though, not only by sale but also through wills, court decrees, and government land grants, so deeds generally speak in terms of a “grantor” instead of “seller.” Grants, property records, and evidence of continued possession can all bear on the state of title.
A deed should convey good and marketable title; “good” means that the title is valid, and “marketable” means that it is reasonably free from doubt or litigation, so that it can be readily sold. A title can – and usually does – have some encumbrances on it, such as easements, leases or mortgages, but the deed should describe all these, so that the property can be appropriately valued.
There are three general ways to gain assurance of good and marketable title.
- Warranties on the deed
- Title search (abstract) and legal opinion
- Title insurance
Deed Warranties. Deeds can offer warranties about the quality of title, but can only convey the quality of title that the grantor actually has – so most people still seek a third-party assurance as to good and marketable title. In a general warranty deed, the grantor promises (or “warrants”) that, among other things, he (i) has legally valid title to the property, (ii) has the right to transfer it, (iii) will compensate the grantee for loss as a result of any superior claim to the property, and (iv) has listed all the encumbrances on the property. These promises cover all transfers of the property, even those previous to the grantor’s current ownership.
There are also lesser deed forms. A special warranty deed limits the warranties only to the time that the grantor held the property, and thus does not cover problems caused by previous owners. An “as is” deed transfers property without any warranties at all, in which case the buyer must take the initiative to determine the existence of any imperfections and how to cure them. A sheriff’s or trustee’s deed is a form of “as is” deed received at a foreclosure sale, since the sheriff or trustee is only acting in a representative capacity. Finally, a quitclaim deed just transfers whatever rights the grantor may have in the property – which could be none! They may seem strange, but quitclaim deeds are in fact useful in clearing up technical defects or “clouds” on a title; unlikely, but potential, claimants can simply “quit” their supposed claim in order to eliminate the related risk.
Abstract and Opinion. This method of assuring title involves two steps: (1) doing a search of all the legal instruments in the public record (summarized by the “abstract”) affecting the property’s title, and (2) getting a lawyer’s opinion as to the character of the title. However, this method still doesn’t remove all risk to a property buyer. The lawyer is only reviewing those documents that are described in the public record, and he can’t be responsible for any defect in the title that isn’t disclosed there. As a result, this method has become less commonly used as title insurance became more widely available.
Title Insurance. Title insurance does all that the abstract / legal opinion method of assurance is expected to do, but it also eliminates the risk of unseen hazards by protecting a policyholder against losses that may show up at any future time arising out of any kind of title defect – disclosed or hidden. Information available to title insurance companies is sometimes even more comprehensive than is presented in the public record. If an insurance company is comfortable with all the title evidence it reviews, it will assume the risk of defects that may not be disclosed in the public records, spreading that risk among its many premium payers. Obtaining title insurance can be more expensive than obtaining a lawyer’s opinion, but its comprehensiveness makes it preferred by most investors and lenders, and it is required for mortgages trading in secondary markets.
There are separate title insurance policies for owners and lenders; lender policies are usually paid for by borrowers, while between buyers and sellers the cost is often a negotiating point. Policies are paid for with one-time premiums, which are often regulated by state insurance commissions.
Recording. Having “title” means having proof of ownership, and the documents comprising most of that proof are usually recorded under the recording acts of each state. Recording a mortgage or other claim on real estate gives notice to the world of that claim, and assures that it has precedence against future claims. Conversely, recording protects persons who might otherwise become victims of fraud (for example, if they’re considering a property that had already been sold to someone else), as long as they review the public record. Documents affecting almost every aspect of real estate – deeds, mortgages, liens, long-term leases, easements, restrictive covenants, and purchase options – are covered by recording acts, as are liens for unpaid taxes or contractor payments.
Title searches do not always reflect every potential lien, however. If a contractor or materials supplier remains unpaid, they may not yet have filed their mechanics’ lien at the time of the property’s purchase or financing -- yet that lien will “relate back” and take priority over claims filed after the time when the work was first performed or materials first delivered. Prudent purchasers and lenders will obtain seller (or borrower) affidavits stating that all contractor payments have been made at the time of closing.
Establishing whether a seller or borrower has good and marketable title to a property is an important factor in evaluating a real estate financial decision. Any defects in the title may jeopardize the collateral value of the property for a mortgage lender, and result in a loss of benefits to a new owner. It is important to control and minimize this risk through the use of title insurance or other title assurance methods.