If you've ever owned a home, chances are you've purchased title insurance. In one of the hundreds of pages of loan and closing documents you received and signed, a provision undoubtedly stated that your loan was conditioned upon your purchase of a lender's title insurance policy. Your lender made you buy it because it's THAT important.
Sure, title claims are rare, but that's how insurance works. You buy a policy hoping you never have to use it, and in most cases you never do. But when you do have to use it, you're VERY glad that you bought it. Title insurance is no different, except in most cases it's much cheaper than the car, health, life, and homeowner's insurance policies you gladly shell out hundreds of dollars a year for.
Title insurance is a one-time premium that you pay at the time of closing. It can protect you from defects in title, boundary issues, ordinance violations and other expensive problems that are are caused by no fault of yours. Lender's policies protect lenders up to the outstanding value of the loan, and an owner's policy protects buyers up to the purchase price of the home. When you buy a policy for your lender, you can usually pay a few hundred dollars more for an owner's policy that provides several hundred-thousand dollars of protection.
So what does it protect you from? Title insurance protects against many covered losses, but the common theme is "defects" in title. This happens when someone sells you a house without the full legal right to do so, which may mean you don't fully own your house! Neither the seller or buyer may even know this is happening.
Consider this hypothetical: Mrs. Smith leaves her land in a will to her three sons. Two sons show up to claim their inheritance and swear that their third brother died in a tragic boating accident. The court gives the land to the sons, who build a house on it and sell it to YOUR SELLER. That seller lives in it for 10 years without incident, then sells it to YOU. After a month of peaceful living, Mrs. Smith's third son shows up out of nowhere! He wasn't dead after all and now he want's his share of his mom's (Mrs. Smith) land.... and he's probably entitled to it under the law. So where does that leave you? In decent shape if you have title insurance because your policy will likely pay the cost of defending your ownership and/or paying off the third son. Without title insurance, you're going to have a very expensive legal battle ahead of you.
Another example is when a prior owner builds an addition or other "improvement" on your home without obtaining the necessary permits. Long after you purchase your home, an inspector notices the unapproved addition - maybe he was there inspecting a home improvement project you were trying to do the right way! - and tells you to fix it or remove it. This can be a very expensive proposition, but certain enhanced title policies can protect you from this kind of loss as well.
The takeaway is this: the cost of title insurance is very low compared to the amount of coverage it provides. You may never make a claim, but the risks covered by title insurance are usually unforeseeable, unavoidable, and very expensive. So, its hard to know how much risk you face until after you purchase the house, when its probably too late to purchase title insurance. The low cost is worth the protection and peace of mind.