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One of the most crucial steps to closing a real estate transaction is the title search. As an investor, you need to do prudent research and be 100% sure that the person you're buying from has a clear title to the property. You need to ensure that you're getting a deed and paying the actual property owner (not somebody else who thinks they own the property or is blatantly lying to you and claiming they own it). When I bought my first house, this whole concept really confused me and if you're new to real estate, it may seem confusing to you too…
Why A Clear Title Matters
In a lot of ways, it's a similar process to buying a car.
Suppose you see a car parked in someone's driveway with a “FOR SALE” sign in the window. The car looks nice, so you walk up to the house, knock on the door and say “I saw this car parked in your driveway, is it yours?”
The person replies, “No – but I'll sell it to you for $20,000!“
There's obviously something wrong with this picture. A person can't sell something they don't legally own – and while it sounds like a ridiculous conversation, you'd be surprised at how often I've come across situations just like this in the real estate business.
How does this kind of issue come up in the first place? There are a lot of ways… but most often, I come across people who have inherited a property from their parents or relatives and somewhere along the way, the proper paperwork was never filed to give them the “legal right” to sell the property. Other times, people just buy properties without doing their own due diligence and then THEY get stuck with a property that doesn't have a clear title. As weird as it may sound – a person can actually end up with their name on the tax bill (and in some cases, even on the most recent deed) – but somewhere in the historical “chain of title” (as recorded in the county's records) the property wasn't transferred correctly from a seller to their buyer.
Another key reason you'll want to do a title search is to make sure there aren't any liens or mortgages on the property. Especially when you're offering people a very small amount of cash for their property (like I tend to do), there will be times when they conveniently neglect to mention that they have a $100,000 mortgage or $20,000 construction lien tied to that property. If you fail to catch this in your title search BEFORE closing on the deal, these issues will fall into your lap and become your problem, along with the property itself.
If you spend enough time in the real estate business, you will run into this issue eventually. Unfortunately, when the problem comes up, it doesn't always have a quick and easy solution.
Title Insurance As An Option
Most real estate professionals (realtors, bankers, insurance agents) would like you to believe that the only way to identify these issues is to pay hundreds, even thousands of dollars for a title company to research the property for you and issue a title insurance policy.
In many cases, buying title insurance is a smart move. A title insurance policy is essentially a guarantee from a title company (which usually comes with several conditions) that your property has been reviewed, it has a clear title and is free of any liens, mortgages or other unforeseen issues (unless specifically stated otherwise). In other words – once the transaction is closed, you are the official owner of the property, and there aren't any other hidden parties that have an ownership claim to your property.
I agree to some extent that title insurance usually isn't a bad idea. It gives you a solid layer of protection and can save you time and bring peace of mind – knowing that the process was done right (or at least, you'll have someone to fall back on if something goes wrong in the future).
That being said… what if you get a property under contract for $150 (something I've seen in my line of work quite often)? Can you really justify paying another $450 just for a title insurance policy, thereby tripling your cost to purchase the property? Is it worth paying more for a title insurance policy than for the property itself? Where do you draw the line?? How do you keep these costs from eating away your profit margin on smaller deals like this?
Title Research – The Cheap Way
There is a way to make this process MUCH cheaper (though it does take more time and effort on your part).
The way I handle this is to order an “abstract of title” from a local title agency or a professional abstractor (oftentimes, abstractors are the people a title company will hire to pull these records for them).
Abstractors can be found a few different ways. You can start with a Google search and see where it gets you (google: County Name, State Name, “Title Search”). You can also call your county Register of Deeds and ask if they have any recommendations on who can pull a title search for you. I've found that most Register of Deeds (aka – “County Recorder”) offices have all kinds of connections and can help you find different abstractors at a very reasonable price. Another way is to call your title insurance agency and ask them to pull a title search on the property (NOT a title commitment). This may not be the cheapest way to go, but they can almost always help you.
The price for an abstract of title will vary based on who you talk to, and sometimes you'll need to get prices from a few different sources before you pull the trigger. In my experience, the cost is usually somewhere in the vicinity of $75 – $125 for this service (if the cost gets over-and-above $150, I'd recommend looking elsewhere). It will usually take the abstractor a couple of days (sometimes longer) to pull together a full list of the historical records on that property. Once you get the records back from them, it just a matter of examining each individual deed on record AND making sure there are no mortgages or liens hidden throughout.
When you get your abstract of title, the order of documents are typically laid out chronologically, from the most recent to the oldest record. If done correctly, this should make it easy for you to identify that the order goes from Owner A to Owner B, Owner B to Owner C, Owner C to Owner D, and so on throughout the history of transfers. For example, if John Smith sold the property to Joe Dirt in 1977, then the next deed on record should show Joe Dirt as the seller. If on the other hand, you saw that the next deed on record was Jane Doe selling to Jim Jones in 1988 (skipping over any mention of when Joe Dirt sold the property), this would be a problem. This is called a “break in the chain of title”. If a title company saw this in their research, they would not be able to issue their title insurance policy because there is a clear blemish in the historical records.
If you come across one of these situations, the best case scenario is that the seller might have some of these original missing documents in their files. If they do, you can ask them to get those documents recorded (or you can obtain the documents directly and do it yourself). I've seen this happen a couple of times, but usually we aren't that lucky. In most cases, when we see a significant issue in the title search, we will ultimately walk away from the deal. It isn't fun (because at that point, we've invested the time and money into the title search), but it's A LOT better to be aware of these problems and avoid them than it is to go into it oblivious and end up with a property that isn't really yours (because the seller didn't really have the legal right to sell it in the first place).
Knowing When It's Worth The Price
Admittedly, doing your own title search will open you up to some risk. There is always the possibility that you'll miss a crucial piece of information along the way. However, I've done at least a few dozen title searches on my own and I have never been burned by it.
The only time I ever do my own title search is when the market value of the property is less than $5K (i.e. – I'm talking about some very cheap, “rinky-dink” properties). As soon as I start dealing with properties that are worth more than $5,000, I never leave it to chance. At that point, a full-blown title insurance policy is more than worth the cost. Making sure it's done right and someone else is on the hook for any mistakes can go a LONG way towards my peace of mind (and to me, that's worth a lot).