Why lenders require title insurance

Lenders require title insurance to protect the mortgage they originate. If a past defect—such as a lien, forged deed, unknown heir, or clerical error—later surfaces and undermines the lender’s security interest, the lender could lose the ability to foreclose or be forced into expensive litigation. A lender’s title policy (issued for the loan amount) shifts that financial risk from the lender to the title insurer.

In my practice over 15 years, I’ve seen multiple closings delayed or loans rescinded because of last-minute title defects. Requiring title insurance is a practical, cost-efficient way for lenders to avoid those outcomes and preserve their collateral value.

Brief history and regulatory context

Title insurance emerged in the U.S. in the mid-19th century as land markets grew and deed records became more complex. Rather than insure future risks (like homeowners policies do for hazards), title insurance addresses risks that already exist in the public record or in prior ownership chains.

Title insurance and closing practices are also shaped by federal and state rules. The Consumer Financial Protection Bureau publishes guidance on settlement services and closing disclosure requirements (see CFPB: https://www.consumerfinance.gov/), and state insurance departments regulate title insurance rates and licensing. The American Land Title Association (ALTA) provides standard policy forms used widely across the market (https://www.alta.org/).

How title insurance works (step-by-step)

  1. Title search: The title company or attorney searches public records to trace the chain of title and identify liens, mortgages, easements, judgments, unpaid taxes, and other encumbrances.
  2. Title examination: A licensed examiner reviews the search results and prepares a title commitment or preliminary report that lists exceptions and requirements to insure.
  3. Curative work: If the search reveals defects (e.g., an outstanding lien), the parties typically resolve these before closing—payoffs, releases, recorded affidavits, or corrected documents.
  4. Policy issuance: At closing, the title insurer issues a lender’s policy (required by the mortgagee) and, optionally, an owner’s policy (recommended for buyers). The premium is usually a one-time charge at closing.
  5. Claims and defense: If a covered defect later causes loss, the insurer defends covered claims and pays losses up to the policy limit.

Lender’s policy vs. owner’s policy—key differences

  • Coverage beneficiary:

  • Lender’s policy: protects the lender’s interest (amount of the mortgage). The policy runs down as the loan is paid and generally terminates when the mortgage is satisfied.

  • Owner’s policy: protects the property owner’s equity and legal ownership up to the purchase price and remains effective as long as the owner (or heirs) hold title.

  • Purpose:

  • Lender’s policy ensures the lender can recover its loan value if a title issue subordinates the mortgage or impairs foreclosure.

  • Owner’s policy protects the homeowner from covered title challenges and legal costs that could threaten ownership or equity.

  • Cost:

  • Both are typically paid as a one-time premium at closing. Which party pays can be negotiated and varies by state and local custom; often the buyer pays for the owner’s policy and the lender’s policy is paid by either the buyer or lender depending on negotiation and regulations.

  • Coverage limit:

  • Lender’s policy equals the outstanding loan balance. Owner’s policy equals the property purchase price (or insured amount chosen).

What title insurance covers — and what it usually does not

Common items typically covered (subject to policy language and exceptions):

  • Forged, fabricated, or fraudulent documents in the chain of title
  • Undisclosed heirs or missing signatures on prior conveyances
  • Erroneous public records or indexing errors
  • Unknown liens (mechanic’s liens, tax liens) that predate the policy
  • Boundary or survey disputes tied to pre-policy defects

Common exclusions and limits:

  • Zoning law changes, building code violations, or future eminent domain takings
  • Matters that a survey would reveal unless the policy includes survey coverage
  • Known defects the buyer accepted in writing or that are listed as exceptions in the policy
  • Environmental contamination and certain off-record matters unless specifically insured

Because coverage varies by form and endorsements, always read the policy schedule and exceptions carefully and ask the title agent to explain any listed exceptions.

Typical title problems that prompt lender requirements

  • Unpaid property taxes or municipal liens
  • Prior mortgages, judgments, or bankruptcy-related liens not properly released
  • Forged deeds, falsified signatures, or improperly executed documents
  • Unknown heirs claiming ownership after a seller’s death
  • Incorrect legal descriptions or boundary encroachments revealed by surveys

When any of these issues appear in the chain of title, lenders will normally either require curative steps before closing or demand title insurance to transfer the financial risk to the insurer.

Costs, who pays, and state variation

Title insurance premiums are usually state-regulated or filed with state insurance departments. That means the one-time premium you pay at closing can vary significantly from one state to another. The premium may be based on the loan amount (lender’s policy) or the purchase price (owner’s policy).

Local custom and lender policy determine who pays. Common patterns:

  • Buyer pays for the owner’s policy; lender’s policy may be paid by buyer or lender.
  • In some states, sellers customarily pay for the owner’s policy.

Check your closing disclosure for the exact breakdown. Federal settlement rules (CFPB/TRID) require lenders to provide clear, timely closing disclosures listing title insurance charges (CFPB: https://www.consumerfinance.gov/).

Claims, limits, and subrogation

If a covered title defect surfaces after closing, the title insurer typically has two duties: (1) defend the insured party against covered claims, and (2) pay valid losses up to the policy limit. For a lender’s policy, that limit is usually the loan balance.

If the insurer pays a claim on behalf of the lender, the insurer can seek subrogation against prior responsible parties. In practice, litigation and claim resolution strategies vary and can be time-consuming. That’s why lenders prefer to transfer this exposure to an insurer at closing rather than face uncertain recovery.

Practical tips and strategies (professional guidance)

  • Always obtain an owner’s policy in addition to the lender’s policy. The lender’s policy protects only the lender. An owner’s policy protects your equity and can save thousands if a title claim appears.
  • Order the title search early. Early discovery of defects prevents last-minute closing delays.
  • Read the title commitment and review all exceptions. If a critical exception appears, require curative documents or negotiate a credit at closing.
  • Consider common endorsements (e.g., survey, mechanics’ lien, zoning) if you need extra protections—these endorsements add coverage for specific risks.
  • Use reputable, licensed title companies and check state department of insurance records for complaints and licensing.

In my experience, buyers who skip the owner’s policy often regret it when an old judgment or a missed signature threatens ownership. Paying the one-time premium is usually small compared with the cost of defending title or litigating ownership.

Common misconceptions and mistakes

  • Misconception: Title insurance is only for the lender. Reality: an owner’s policy protects homeowners and is strongly recommended.
  • Mistake: Ignoring policy exceptions. Exceptions define what the insurer will not cover; accepting them without curative steps can leave you exposed.
  • Misconception: Title searches catch every problem. Reality: searches rely on public records and do not guarantee absence of off-record claims or future statutory changes.

Frequently asked questions

Q: Is title insurance a recurring premium?
A: No. Title insurance is generally a one-time premium paid at closing, not an annual fee.

Q: Does title insurance protect against future zoning changes?
A: No. Title insurance typically does not cover future zoning law changes or code violations that arise after the policy date unless you purchase a specialized endorsement.

Q: Can a lender require title insurance as a condition of the loan?
A: Yes. Lenders usually require a lender’s title insurance policy as a condition of funding to protect their collateral.

Q: How do I choose a title company?
A: Choose a licensed company with a good track record, clear communication, and disclosed fees. Ask for references and verify licensing with your state insurance department.

When title issues can block closing

Unresolved liens, missing signatures, or unacceptable exceptions in the title commitment can delay or block a mortgage closing. For more detail on common title issues that can delay closings, see our guide: Title Issues That Can Block a Mortgage Closing.

If an issue is minor, lenders will often require curative steps and a lender’s policy. If the issue is material and unresolved, lenders may withhold funding.

Related resources on FinHelp

Professional disclaimer

This article is educational and does not constitute legal or financial advice. Rules, forms, and state practices vary; consult a licensed real estate attorney, your lender, or your state insurance department about specifics for your transaction.

Authoritative sources

If you’d like, I can adapt this entry to a specific state (example: California, Texas, or New York) and include state-specific premium rules, typical payer customs, and direct links to state insurance departments.