If you've ever bought a home, you're quite familiar with the long and involved process that you have to go through before you can walk in the door. As a previous article on getting a home inspection mentioned, you not only have to find a home you actually like, but you also have to make your way through a bunch of red tape to get everything squared away. At first, it may seem silly to wait two or three months between the time you sign your contract until closing, but once you see how many steps are involved in completing your purchase, you'll understand why everyone builds in enough time to take care of every possible loose end.

One of the loose ends that most people will have to deal with in buying a home is obtaining title insurance. While most banks and other mortgage lenders require title insurance as a condition of giving you your loan, buying title insurance is often a good idea even if your loan doesn't require you to get it. If you're not required to buy title insurance, your decision should depend on the risks that someone will challenge your rights to the property after you've purchased it.

The basics of title insurance
The purpose of title insurance is to make sure that when you buy real estate from someone, you actually have complete ownership of the property after the purchase. At first, that may seem like a trivial thing. After all, by the time you close, you and a bunch of other people will have spent months focusing on your property, so you'd expect that someone would figure out whether another person claimed to own the property. However, it turns out that property laws and other legal provisions that affect property ownership can be more complicated than you would expect.

Part of the reason why mortgage lenders require title insurance is that it's relatively easy to transfer real estate informally under the laws of most states. For instance, if you want to give your property to someone, all you have to do is write up and sign a legal document called a real estate deed, which names the person you want to receive the property. While state and local governments have provisions that allow you to record these real estate deeds in a way that makes them available to the general public, recording a deed isn't absolutely necessary in most cases to make the transfer of property legal. As a result, there's always a chance that months or years after you complete the purchase of your property, one or more long lost family members will come out of the woodwork, claiming that your purchase transaction was invalid because the former owner gave the property to them first.

What title insurance gets you
In a dispute over your title to a piece of real estate, arguments can quickly escalate into costly and time-consuming legal battles that involve substantial risk that you might lose your property. In order to protect you against that risk, title insurance companies offer to sell you a policy that will cover any losses or damages that result from defects in your legal title to the property. In other words, if someone challenges your right to your property, a title insurance policy will protect you by allowing you to call on the title insurance company to defend your interests against the challenger.

Of course, title insurance companies don't want to spend the time and money involved in fighting legal battles on a regular basis. Before issuing a policy, title insurance companies perform a thorough check of the property's history of ownership. The goal of this search is to establish a valid chain of title that links legal ownership from the first person ever to own the property down to the current property owner. In some cases, the company will find a completely clean chain of title and be able to issue a policy with no exceptions. However, if the search reveals irregularities in the chain of title, then your policy may include an exception to coverage for any claims related to those irregularities. Clearly, your goal as the property owner is to have as few exceptions to your title policy as possible.

A lucrative but necessary business
Many title insurance companies are quite profitable. Companies like Fidelity National (NYSE:FNF), First American (NYSE:FAF), and Stewart Information Services (NYSE:STC) have all performed well, as the boom of the housing industry carried over to their title policy business. Because banks have to have title insurance in order to sell mortgage loans to national firms like Fannie Mae (NYSE:FNM), there's an almost guaranteed amount of continuing business that these firms will enjoy well into the future.

Title insurance policy costs can vary widely, mostly depending on the value of your home and its location. Depending on the common practice where you live, the seller may be responsible for obtaining title insurance as part of the sale, or the buyer may have to pay for the insurance if it's needed. As with many other types of insurance, the probability of loss may be relatively low, but the potential impact of a loss is devastating. Buying title insurance gives you the security that you won't lose your property as a result of some legal technicality that you could never have expected.

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If you're buying or selling a home, check out the Fool's Home Center. You'll find a bunch of informative material, money-saving tips, and even specials on mortgage rates.

Fool contributor Dan Caplinger has to buy a title insurance policy to cover his bank's mortgage loan. He doesn't own shares of the companies mentioned in this article. Fannie Mae and First American are Inside Value selections. The Fool's disclosure policy won't leave you out in the cold.