A cloud on a title is a term used in real estate to refer to any claim or encumbrance -- such as a mortgage lien or unpaid taxes -- that could nullify or cast doubt on the title. Clouded titles are discovered during a title search and can usually be resolved by filing a quiet title action or a quitclaim deed. However, there will be delays in completing any sales or transfer of property that has a clouded title.
Let's take a closer look at clouds on titles and what they mean for property investors.
What does a cloud on a title involve?
Any property issues that remain unresolved will appear as a cloud on a title. This may include:
Liens. A lien usually involves outstanding mortgage debt or unpaid taxes. It also applies to situations where someone has free and clear ownership of a property, but they used it as collateral for a new loan. To resolve the cloud on the title, the lien must be paid.
Foreclosure. In the case of a foreclosed property, the lender may prevent the borrower from selling the real property while it's in foreclosure proceedings.
Mechanic's lien. If construction or renovation work was done on the property but was never paid for, the contractor will put a lien on the property, though not on the owner themselves. This means that if the property is transferred to new ownership, the new owner will be responsible for paying the contractor to clear the encumbrance. Depending on the amount of work done, a mechanic's lien could add up to big bucks -- and therefore be a big turn-off to potential investors.
Probate. A clouded title could also be the result of problems with documents and claims associated with estates and wills, especially with older properties whose documents may not be readily available. Should there be any confusion as to who has rightfully inherited a property, there could be a challenge in court by any potential heirs, thus leading to a cloud on the title.
Fraud. If a fake deed has previously been accepted as a legitimate one, then there's a cloud on the title until the true homeowner is identified.
How to resolve a cloud on a title
There are two common ways for a title on a cloud to be resolved: a quitclaim deed and a quiet title action.
A quitclaim deed is used in property transactions that don't involve a financial transaction, such as the transfer of property between family members. They are also used to correct title clouds. An individual (grantor) can sign a quitclaim deed to convey any remaining interest in a property to the new owner (grantee) along with a clear title.
Quiet title action
A quiet title action is a lawsuit filed with the intention of settling any disagreements regarding a property title. Like the name suggests, it's meant to silence or remove any claims or objectives others may have regarding a property.
There are numerous situations in which a quiet title action may be used:
- In the case of an owner's death to ensure that all heirs have been notified of a property's impending sale.
- To take care of any issues with a lender that may continue to linger even after the mortgage was paid off.
- To free a title on an unoccupied property and allow it to be sold.
- To resolve a boundary dispute.
- To clarify competing claims on a property.
- To clear up tax issues.
- To correct survey errors.
- To transfer a title to the rightful owner in a situation where squatters have occupied the property.
Why title clouds are a problem -- and how to avoid them
Real estate sales rarely happen quickly, even when all things seem to promise a smooth transaction. So when a cloud on a title pops up, it can cause uneasiness for a potential buyer. Experienced investors who have bought foreclosed and abandoned properties are used to delays, but for first-time owners or newer investors, long delays could cause them to pull out of the deal.
The best way to avoid a clouded title as a property owner is to keep current with all mortgage and tax payments. When there are no liens on a property, you can ensure a much easier sales transaction -- something obviously desirable for a potential buyer.
Another way is to take out a policy for title insurance. If you have a mortgage, this is usually a requirement, but if you own the property outright, it's still a good idea to have it so as to avoid any issues with the property title.
The bottom line
A cloud on a title can lead to some stormy weather for your real estate transaction, but these clouds too shall pass. While avoiding title issues in the first place is always best, there are ways to clear up the cloud and move on with the transfer or sale of property.