Title insurance protects lenders and property owners from several types of title issues that can affect ownership of a piece of property. If you are working on a construction project that has title insurance, you may wonder what that means – and how it affects your ability to file a mechanics lien if necessary.
These policies cover costs for clearing mechanics liens and other encumbrances on a title. If you are involved in a project with this type of coverage, you need to know what may be covered, and how to protect yourself from non-payment.
What is title insurance?
Title insurance is a type of policy purchased by either the lender and/or the owner during a property purchase or in closing a construction loan. Both the owner and the lender can purchase their own policies. In some cases, each may be required to as part of a financing agreement.
At the time of purchase or loan closing, the title company searches for and remedies any ownership issues, including past mechanics liens. Then an insurance policy is issued that covers future costs for satisfying undiscovered past liens, determining correct ownership if there is a dispute, and any other unknown costs necessary to clean up the title. The policy ensures that the owner will have clear ownership, the lender will have clear mortgage lien rights, and that there aren’t any other issues.
A title insurance policy protects the purchaser from problems incurred before the date of the policy that may be found after the policy is purchased.
Let’s say, for example, that a lien was mistakenly filed three months ago on an incorrect property but was meant for the one currently being purchased. That error isn’t caught until the contractor perfects the lien, but there is still time to notify the correct owner of the unpaid balance.
Once the lender and title company become aware of the problem on the property being purchased, the insurance policy would cover the cost to have the lien removed, as long as the work was done before the purchase date.
What does it cover?
Title insurance covers many title problems, including:
- Errors in public records: Clerical or filing errors can affect the deed or survey of the property.
- Illegal deeds: If a previous deed was signed by an undocumented immigrant, a minor, or even someone who said they were single but were actually married, it can call into question the chain of ownership.
- Forgery and fraud: Forged or fraudulent documents may have been filed, calling into question the rightful ownership of the property.
- Unknown liens (filed prior to purchase): If the past owner didn’t pay their bills and liens were filed against the property, title insurance will pay for their release.
Lenders purchase title insurance to protect their mortgage lien interest until the loan is paid off. They want to make sure that they have first dibs on the proceeds from a sale if the loan becomes delinquent. If construction is going to take place after the property purchase or closing of a construction loan, then the lender will probably purchase additional endorsements to cover the construction costs throughout the project.
Property owners or buyers purchase this insurance to ensure their ownership rights are covered during a purchase. Standard coverage also protects them from liens on past work, for as long as the property is owned by that owner. If the new owner plans to do construction, then they may choose to upgrade their coverage with additional endorsements to cover construction work in progress.
Construction loan protection
When a property owner decides to undertake a construction project and requests financing to do so, title insurance can be added to the construction project loan. Usually the lender will purchase a policy to protect their lien rights throughout the project and during repayment of the loan.
Standard title insurance policy
A standard title insurance policy for a construction loan contains language (Covered Risk 11(a), ALTA, Loan Policy for those that are interested) that excludes mechanics lien coverage, except for liens filed prior to the date of the policy or after the date of the policy if the lender advances all the funds at the beginning of the project.
So, if a lien was filed prior to the closing of the construction loan, the title insurance policy will pay for its release. Also, if the lender gives the owner all of the loan funds prior to the project starting, and then a lien is filed during the project, standard title insurance will cover those costs.
Pending Disbursement Clause
If the construction loan isn’t going to be funded up-front, but will be disbursed as the work progresses, then a Pending Disbursement Clause may be added to the insurance policy.
This clause limits the amount of lien coverage to the total of the funds already disbursed. When this clause is in place, the lender will probably do title research after each draw is disbursed to ensure that no liens have been filed and to protect its lien priority.
These clauses may require additional documentation from the contractor, including signed lien waivers and proof of bill payment.
Lenders can also request additional title insurance endorsements (ALTA endorsements 32-06, 32.1-06, 32.2-06, and 33-06) that provide direct mechanics lien protection during a project. These endorsements cover different types of costs paid by different parties. Together they provide coverage for any liens filed throughout the life of the project. The insurance policy will pay any outstanding amounts to clear the liens and maintain the lender’s lien priority.
How title insurance affects a contractor’s payment rights
Fortunately for contractors, title insurance doesn’t affect their right – or their ability – to get paid.
The mechanics lien process is the same whether the property has title insurance or not. You still must abide by the notice deadlines and requirements for the state the project is in. You should continue to communicate with all parties to the project (owner, lender, and your client) when there is a payment issue.
The only difference will be that the lender may file a claim with title insurance policy to cover the costs of paying off your lien and any fees. So, instead of receiving a check from the property owner or the lender, you may receive payment from the title company.
Title insurance provides another avenue for a contractor to get paid if your customer or the lender aren’t releasing funds. The policy will pay to release mechanics liens placed on a property during construction. You will still need to file the required notices and notify the lender and all parties of your payment issues.
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