by Katie O'Brien
Title insurance serves several important functions for lenders. It insures that the lien created by the mortgage, deed of trust or security deed is valid and enforceable and is in the proper lien position. It also insures that title to the insured real estate is in the name of the borrower or guarantor, that there is access to the real estate and that title is marketable.
It is standard practice for a lender to obtain a lender’s title policy when the lender is financing the purchase of real property or refinancing a real estate loan. For conventional real estate loans, title insurance is generally obtained in the amount of the loan; however, SBA loans raise a unique question regarding how much title insurance is sufficient. Because SBA loans are often severely undercollateralized, there can be a large discrepancy between the value of the real estate and the amount of the loan. So while obtaining title insurance in the amount of the loan might make sense for conventional loans that are otherwise fully collateralized by the real estate being insured, such a practice does not always make sense in the SBA world.
The reason for this is that claims under a title insurance policy are limited to the lesser of:
– the fair market value of the insured property,
– the face amount of the policy, or
– the actual loss sustained by the policy holder
For example, if a $2,000,000
SBA loan is secured by real property which appraised at $500,000, it may not make sense to require a lender’s title policy for the full amount of the loan. Even if the lender has a $2,000,000 policy, they will not be able to recover more than the fair market value of the real estate in the event of a claim.
So how much title insurance should you obtain? The SBA does not have any specific requirements, so a prudent lending standard controls. Some lenders may be comfortable obtaining title insurance in the amount of the appraised value of the real estate. A more conservative approach, though, would be to obtain insurance in an amount above the appraised value of the real estate because the value of the real estate could increase in the future and lenders may want to maximize their potential recovery under the policy. So obtaining insurance for 125% or 150% of the appraised value may be a good approach for some lenders. There is no right or wrong answer, but lenders should consider the specifics of the deal and decide how much title insurance is prudent for each loan in order to adequately protect the lender without making the borrower pay unnecessary costs. Requesting insurance for the full amount of the loan might not give a lender any additional protection and could increase a borrower’s closing costs unnecessarily.
For more information regarding title insurance practices in SBA lending, contact Katie at KOBrien@StarfieldSmith.com or 215-542-7070.