Simply finding the perfect borrower can seem like an arduous process—but the search for the borrower and real property collateral is just the beginning of your lending journey.
A property may look perfect during a loan application, but how do you know there aren’t any unresolved liens from the previous owner? Or if there are any restrictive covenants that could potentially interfere with your future use or enjoyment of the property if you need to foreclose?
That’s where the preliminary report comes into play. This document provides lenders the opportunity to review any issues that their title insurance won’t cover unless resolved that are associated with the property before they commit to financing the loan. Here’s a closer look at this useful tool and how to best utilize the information it provides when acquiring real estate.
Preliminary Report Basics
The preliminary report is drafted before the title insurance policy is issued and indicates details related to the legal ownership of a given piece of property. It includes any existing liens and encumbrances that the pending title insurance policy will not cover. Title compiles the report by completing a detailed review of recorded documents pertaining to both the parcel of land and both parties involved in the transaction. Any subsequent issues that are uncovered during this process are listed in the preliminary report in numerical order as “exceptions.” If an exception is listed on the preliminary title report it is not set in stone, as there is a period where the lender can request that items be removed from title prior to closing.
Analyzing a Preliminary Report
What exactly should you pay attention to in a preliminary report? As a lender, your main focus is determining the scope of your borrower’s ownership rights. To that end, you’ll want to direct your attention to the report’s statement concerning the degree, quantity, nature, and extent of the borrower’s current and future ownership interest. This is because you may need to step into the borrower’s shoes and take over ownership of the property. The majority of transactions involve either a “fee simple” or “fee” interest, which is the highest degree of interest that a property owner can possess over real property.
As noted before, any liens, restrictions, and competing interests outside the scope of the title insurance policy coverage are labeled “exceptions” in the preliminary report. These could be liens by creditors against the owner or outstanding debts for taxes or assessments. Other potential exceptions include any covenants, conditions, and restrictions (CC&Rs) stated in a previous deed or third-party interests in the form of easements that could dictate the way you can use your future property.
Preliminary reports also typically contain an exhibit outlining a list of standard exceptions and exclusions of items that the future title policy will not cover. It is important to thoroughly review these exclusions, as it presents potential issues for which you will not receive compensation. Common examples of standard exceptions include municipal regulations or state/local laws related to construction and zoning permissions. If you have plans to make any additions or alterations to the property, it would be beneficial to ensure there are no official restrictions that could prevent you from doing so.
It is important to understand that the preliminary report is not a comprehensive overview of the condition of title and does not necessarily include all pertinent liens, defects and encumbrances that could negatively impact title to the property. The report is simply an outline of the present ownership and issues that the title company will not cover in the event that they issue a policy. You may request that items on the exceptions be removed or resolved prior to closing in order to protect your interests.
A preliminary report alone does not confer title insurance coverage. Instead, it is an offer from the title insurance policy provider to insure the property. This distinction is essential because there is no contract or liability between the lender and title insurance company until after the policy itself is issued. Title insurance companies can, however, offer protection against potential title complications arising before the close of the transaction via “binders” and “commitments.” Binders are agreements between the buyer and insurance provider granting temporary coverage until the official policy is issued. A commitment, on the other hand, refers to the provider’s contractually required obligation to insure title to a real estate asset after all of its stated prerequisites have been fulfilled.
In an industry that is premised on mitigating risk, documents like preliminary reports play a key role in facilitating the issuance of title insurance policies—an important step in any real estate transaction to protect the lender from unforeseen issues down the road.