At it’s most basic level, Insurance products are a way to Manage Risk. In the context of a real estate transaction, you will stumble upon insurance in a number of ways…
Title Insurance is perhaps the first form of insurance that comes to mind when buying a home, and for good reason. The Title Insurance serves a critical safeguard against a homeowner’s risk in a transaction. First, The Title search of the County Clerk records is conducted to confirm that the Seller has the legal authority to sign a Deed, which is the document transferring ownership from Seller to Buyer. If there are any breaks in the prior chain of ownership, the title company alerts all sides, and requires the Seller to cure that issue before a closing can happen. Additionally, after the Title Company confirms that the Seller can give ownership of the home to the buyer, the Title Company is charged with confirming that the Buyer’s ownership of the home is “clean,” and not subject to any liens, judgements, mortgages, back taxes, etc.. They also confirm that there are no bankruptcies on either side of the deal which would require court approval of the sale.
A major search associated with the Title Search is referred to as the MUNICIPAL SEARCH. The title company asks the town’s Building Inspector for a copy of a Certificate of Occupancy for the house (or a statement that none is needed if the home was built before needing one), and whether the town is AWARE of any violations at the home. A violation can be work done on the home that was not up to the standards of the building code at the time the work was done, or more commonly, work that was done without the town issuing a building permit and certificate of occupancy/compliance. Two important notes here. 1. The town very carefully words their letter response that they are or aren’t AWARE of a violation; they don’t guarantee there are none, as in most cases, they don’t go into the home to poke around. 2. The Municipal Letter is something the title company is charged with requesting, but the letter is NOT a matter that is insured. It is for informational purposes only.
Once the Title Search is complete and any objections addressed, the title company is willing to issue Title Insurance which essentially states that if there is ever a question of ownership, or a lien or judgment or other “cloud on title” that happened before the closing, the Title Company’s insurer will both defend (hire an attorney to represent you) and indemnify (pay any valid claims that arise due to issues arising before your closing) the buyer.
Title Insurance Premiums are NOT a recurring payment, and are only paid at the closing.
The next common insurance product you encounter when buying a home is Homeowner’s Insurance (sometimes called “Hazard Insurance”). This insurance will be required to be paid as of the moment of closing, and, like title insurance, serves several purposes. Homeowner’s Insurance insures the homeowner against the risk of loss or damage to the home as a result of fire or other “casualty” loss, and gives the homeowner funds to repair or rebuild the home. The policy also insures the homeowner for losses related to the contents in the home. Further, the homeowner’s insurance policy covers the homeowner for any claims or lawsuits by invitees to the home claiming your negligence (trip and fall on your driveway, dog bite, etc).
Your lender will not allow you to close without obtaining homeowner’s insurance, as they want the asset that backs up your promise to re pay their loan to be protected. But even if you don’t have a lender requiring it, a buyer would be foolish not to secure homeowner’s insurance prior to closing.
Homeowners Insurance is a recurring cost, and the premium is generally payable annually.
PRIVATE MORTGAGE INSURANCE
The last common type of insurance you may encounter in your purchase will be Private Mortgage Insurance, or “PMI.”
For context, remember that when the bank has you sign a loan where they front you money to buy a house, and you agree to pay it back over the next 30 year (the promissory note), the bank ALSO makes you sign a Mortgage. Despite most people referring to the “Mortgage” as the loan, it’s not. The Promissory Note is the loan. By contrast, the Mortgage is a document that basically pledges the house as back up for your promise to repay the loan. The Mortgage makes the house the “collateral.” You fail to timely pay back your Promissory Note, the bank uses the Mortgage sue you (Foreclosure) and get a Judge’s authority to sell the house at public auction and apply the proceeds to the balance of your loan. (We like to call that Plan B)
Sometimes real estate markets decline in the years after a loan is issued, and also, a public auction is not such a great way for a bank to get fair market value for a home.
So in cases where the buyer does not have a ton of skin in the game, the bank will insist on the buyer paying PMI (Private Mortgage Insurance) to cover the foreclosing bank’s risk that the auction won’t be enough to cover the loan balance with costs and fees. Note that PMI ONLY covers your BANK for a loss resulting from a foreclosure, NOT the borrower.
PMI is usually required when a buyer is putting less than 20% cash into the purchase. PMI is usually paid monthy with the loan and tax escrow payments, and will continue until the bank’s analysis estimates that the homeowner reaches the magic 20% equity ownership in the home based on the homes value at the closing and future mortgage payments. Also, most banks will allow a borrower to request that PMI be dropped when the borrower feels the real estate market has grown such that they now have 20% equity. In those cases, the borrower would likely be asked by the bank to pay the cost of an appraisal to confirm the increased value of the home.