What happens to a loan title policy after foreclosure?
Most institutional lenders obtain a loan title policy (paid for by the borrower) when lending money secured by real property. The loan title policy amount is typically the amount of the original principal balance of the loan. When that lender or its assignee forecloses and takes title by a certificate of title or takes a deed in lieu of foreclosure what title insurance coverage does the lender then have?
There is a common misunderstanding that the lender ends up with an owner’s title policy after foreclosure or a deed in lieu without obtaining a new owner’s policy. This is incorrect. The coverage after foreclosure or a deed in lieu is the same coverage the lender had under its loan policy before either of these events.
A loan title policy does not provide as comprehensive coverage as an owner’s policy. One of the major differences between an owner’s title policy and a loan title policy is determination of whether there is a loss and measurement of damages. If there is a defect in title, under an owner’s title policy the loss and the measure of damages is generally the difference in value of the property with and without the title defect. There is only a loss under a loan title policy however, if the value of the property adjusted for the defect is (i) less than the face amount of insurance of the title policy and (ii) also less than the amount of the debt owed.
To illustrate the loss analysis under a loan title policy, assume the lender acquired a loan title policy for $120,000 when it made a mortgage loan in that amount and the amount outstanding on that loan at the time of filing the foreclosure is $100,000. Assume further that there is a title defect of a $20,000 superior mortgage debt that was missed in the title search and not shown as an exception in the loan title policy. (Please note that the date to measure damages could be different and is not a settled concept under existing case law). Assume the value of the property without considering the defect is $130,000. In this illustration, the lender has no loss since the value of the property with the defect is $110,000 ($130,000 less the $20,000 superior debt) and the amount owed is $100,000.
Now assume the same facts except that the amount owed is $120,000. In that case, there would be a $10,000 loss to claim under the policy since the policy amount was $120,000 and the debt owed is $10,000 more than $110,000, the value of the property adjusted for the defect ($130,000 less $20,000).
If the facts were the same as the foregoing paragraph except the total debt were say $125,000, the title company would still only be responsible for a $10,000 loss because the face amount of the policy was for $120,000.
A lender acquiring property via foreclosure or deed in lieu may want to consider whether to purchase an owner’s title policy at the time of acquisition of the property (certificate of sale or deed in lieu) for the following reasons. The loan title policy keeps the same effective date. Accordingly, any title matters subsequent to the loan title policy date, e.g., defects in the foreclosure process, are not covered. In addition, the lender is not protected from liability for any deed warranties it may give when selling the property after foreclosure or a deed in lieu. Also, an owner’s title policy would cover the actual value of the property at the time of acquisition by foreclosure sale or deed in lieu rather than an amount that may be below the value of the property.
The lender will of course need to weigh the cost and benefits of obtaining an owner’s title policy upon obtaining a deed in lieu acquisition at foreclosure. In making that decision the lender should consider such matters as how long they expect to hold the property; will the buyer from the lender require warranties of title; and does the debt and the value of the property exceed the original face amount of the policy such that the lender, as now owner, wants to protect the additional value? There may be other considerations not mentioned here, but in order to evaluate them it is important to know the distinctions of an owner’s policy and a loan policy and that the loan policy remains a loan policy even after the lender acquires the property through a deed in lieu or a foreclosure sale.
This is not intended to be legal advice for any specific situation and the reader should consult their attorney regarding their situation.