When you decide to build a home, you will typically obtain a construction loan. A construction loan is a temporary loan used to finance the building project until the owner or buyer obtains a permanent mortgage. Before a lender will authorize the construction loan, the lender will usually require the borrower to purchase a title insurance policy.
About Title Insurance
There are different types of title insurance. The title insurance you will be required to purchase for a construction loan is lender's title insurance. If someone files a lien on the property, lender's title insurance will protect the lender's interests in the property. Lender's title insurance policies typically cover the dollar amount of the loan and will remain valid until you re-pay the loan.
When a company or an individual provides services, material or equipment to a property and does not receive full compensation, the company or individual can place a mechanic's lien on the property. A mechanic's lien is the most common type of title defect that can arise during the construction process. With a mechanic's lien on the title, the property owner cannot sell the property without compensating the person who filed the lien.
Avoiding Mechanic's Liens
If someone places a mechanic's lien on the property, the lender will not authorize the next disbursement from your construction loan. There are several things you can do to avoid mechanic's liens. Performing updated title searches during construction will ensure that no liens are on the title at any given time. You can also require contractors to sign lien waivers after they receive compensation. Lien waivers prevent contractors from being able to place any liens on the property in the future.
Owner's Title Insurance
Once the building project is complete and you secure a permanent mortgage, you can purchase an owner's title insurance policy. This policy will protect your interests in the property should any title defects arise in the future. Possible title defects include mechanic's liens, fraud and forgery, and omissions or mistakes in property deeds. In most cases, you will also need to purchase another lender's title insurance policy at the closing of your permanent mortgage.