Title, Personal Mortgage and Mortgage Life Insurance

April 13, 2006

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A small business owner needs to carry various types of property insurance coverage, but he or she also needs to understand the limits of general coverage.

So, a number of specialized property policies should be considered when seeking to protect your real property assets. Some people often confuse these policies with one another or mistakenly believe that their general property policies cover these situations. They do not.

Title insurance. This protects the title to the property. It does not protect against loss due to fire or any other hazard. It protects against the possibility that a purchaser of real property (land and buildings) has obtained an invalid legal title. The policy pays off if the owner loses ownership of the property because his title to the property turns out to be defective.

A title search (i.e., an examination of the chain of title, as it appears on the land records) should always be done before real property is purchased. Most states require that an unbroken chain of title go back 40 or 60 years.

The title searcher will determine that the seller's signature appeared on each deed, that it was properly witnessed and acknowledged, and that the legal description of the property is identical in each deed.

Why is title insurance necessary if a title search is completed? A title search cannot absolutely ensure that the title is valid. For example, there is no way of determining, through a title search, that every signature on a deed is genuine. If one signature anywhere in the chain of title was forged, the chain is broken and the current owner holds an invalid title. A holder of an invalid title cannot, as a general rule, make a transfer to a buyer.

When the real property is collateral for a loan, the mortgagee (the lender) usually will require that the purchaser obtain a mortgagee title insurance policy.

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The small business owner should also be sure to purchase an owner's title insurance policy. The mortgagee title policy, which will be issued in the amount of the mortgage, only pays off to the mortgagee in the event of a covered loss. Thus, a mortgagee title policy protects the lender's property interest in the real property.

However, a mortgagee title policy also protects the owner. If the owner loses title to the property, the mortgage title insurance policy ensures that the owner will not have to continue to make payments on property he no longer owns.

Ultimately, a mortgagee title insurance policy alone is not sufficient protection. An owner's title policy will protect the owner's equity in the property and will pay off to the owner if a covered loss occurs.

Unlike virtually every other form of insurance, title insurance requires only the payment of a single, lump-sum premium, which is due upon the purchase of the property, as opposed to ongoing premiums. Usually, the owner's policy will contain an inflation endorsement that automatically raises the policy limit each year, in accordance with a prescribed formula.

Personal Mortgage Insurance (PMI). PMI is entirely different from title insurance in that it offers protection only for the lender. This insurance pays off the lender in the event the borrower defaults on the mortgage. Lenders generally require PMI whenever the down payment on a purchase is less that 20 percent of the purchase price. PMI premiums can be expensive. Usually, advance payment of the first year's premium is due, in one lump sum, upon purchase. A monthly premium is then added to the mortgage payment.

PMI can be terminated when the equity in the property reaches 20 percent due to payments of mortgage principal, appreciation in the value of the property, or both. Lenders require an appraisal to establish that the 20 percent threshold has been reached.

Note that hazard insurance, title insurance and PMI represent examples of the principle of relying on another person's insurance. The owner of the property will be compelled by the lender to pay for the insurance, even though the lender will be a beneficiary of the insurance.

Mortgage life insurance. An owner of real property, who has taken out a mortgage on the property, can purchase mortgage life insurance. This form of insurance pays off the mortgage upon the death of the mortgagor/owner. While this may seem desirable, the high-cost premiums are not usually justified by the benefit. Premiums remain level, even as the policy's benefit (i.e., the mortgage balance) decreases.

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Usually, a separate term life insurance policy, with the party who will inherit the real property named as the beneficiary, will represent a better use of your insurance funds than mortgage life insurance.