Buying Foreclosures: “Insurable Title”

Buyer beware.  The verdict and key point of this post:

During your due diligence period if you purchase foreclosure property you need to engage your own lawyer to give you a summary of the status of title before you close on foreclosure property.   This will inform you know as to what, if any, lingering liens and other title defects exist for the property.

Here is the background.  If you purchase foreclosure real estate you need to keep in mind the distinction between “marketable title” versus “insurable title”. Most selling banks will require an addendum to the property purchase contract specifying the bank at closing will give the buyer only insurable title (again, not marketable title). Banks will often also include a provision in the addendum to pay and provide the buyer at closing with a policy of title insurance limited, however, to insurable title.  Sounds great, right?

Well, not completely great. This payment of title insurance by the bank for the buyer is not a gratuitous gesture on the bank’s part; but, its payment of this title insurance helps the bank move the sale process along without the buyer seeking out an independent review of the title status.

Keep in mind the status of title deals with whether there are any impediments to the property deed, such as recorded federal or state tax liens, unpaid property taxes, judgments, mechanic’s liens, and so forth.

Here in brief is how the marketable and insurable distinction plays out:

First, if a seller under the contract gives the buyer marketable title at closing (not insurable title), this means the seller must remedy any defects in title prior to closing, such as the seller paying off any liens, or doing all the work necessary to get the liens removed, etc.  Thus, at closing the defects have been cured by the seller.

Second, and by contrast, a seller giving you insurable title does not require the seller to cure title problems at closing.  It means only that these problems are insured post-closing under the terms of your title insurance.  The closing is completed with these title defects unresolved.

Here is the rub. Insurable title means the title insurance will step in after the closing and defend the buyer but only if any of the lien or judgment holders actually step forward and levy the claim against the real property.  Thus, only then will the title insurance company defend and cure these claims. This sounds great, doesn’t it?  Well, yes, but only to some degree. Insurable title enables a smooth closing when you purchase the foreclosure property;  but, it also makes the title defects potential sleeping giants.

And, even if the giants never awaken, when you later sell the property your buyer will most likely require that you convey marketable title (which is typically the case). In order for you to transfer marketable title, you will have to do all the work (including possible negotiation and payment to satisfy the liens, judgments, etc.) so that you can transfer a deed at your closing that is free of title defects.  In other words, you are responsible for the title clean-up when you later sell the foreclosure property.

Finally, in some cases the title defects are so great that the title insurance company will not insure even with this insurable title.

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