Lender’s Title Insurance: It's No Guarantee

Title insurance is an indemnification contract, like many other types of insurance. Just as a life insurance policy does not ensure you will live forever, a title insurance policy does not guarantee that your title is valid, but merely provides the insured with compensation to offset the loss sustained as a result of title not being as insured.

The Policy Conditions and Stipulations provide, amongst other things, that upon notification of the defect, the title company may either cure the defect or pay the claim. Additionally, the title company may provide an indemnification to third parties to avoid the insured sustaining any loss and thus avoiding the necessity to compensate the insured. It is only when the insured has actually suffered a loss resulting from the title defect that the company must pay the claim.

The most common title claims a lender will have include:

  • Prior mortgages, judgments or other liens
  • Errors in the legal description
  • Forgery

Although lenders are insured against loss arising from all of these risks by title insurance, the title company will handle claims for each in a very different manner.

For example, a lender believes that it holds a 1st mortgage, but discovers a prior mortgage encumbering the property that was not disclosed by their title report. As long as the borrower pays what is owed, the lender has not actually suffered a loss. Even if the borrower defaults and the lender is constrained to foreclose its mortgage, until the foreclosure sale is held and no third party purchases the property, the title company is not required to compensate the lender as the lender has not yet “suffered a loss.”

Upon discovery of a prior lien, the lender must notify the title company and submit a claim. Typically, the claim will be processed and the company will issue its letter of indemnification, commonly known in the trade as a “happy letter.” This is simply a letter in which the insurance company confirms its responsibility and confirms that if the property is foreclosed, the title company will insure the next purchaser against loss without delay.

As for errors discovered in the legal description, the title company will typically request the foreclosure attorney to obtain an order from the court, correcting the error as part of the foreclosure. Although the title company will pay the foreclosure attorney’s legal fees for the additional work this entails, there will, again, be no payment to the lender required from the title company, as this avoids any loss.

As for the more serious defects, such as forgery (click the link to see my previous article on forgery), the title company will retain an attorney at its sole expense to cure the defect or offset the loss by litigation. Failing to do so will pay the insured the actual amount of their loss, but not more than the policy amount, so interest, tax advances, etc. may not be reimbursed.