Title insurance: what lenders should know

RMA Journal, The, Nov, 2003 by Bernard Bittner

Mortgages come in many flavors, and the author provides examples of how a plain-vanilla title insurance policy can lead to insufficient coverage. Endorsements can cover these shortcomings.

Although most banking professionals and regulators would concur that lending institutions should not self-insure title insurance risk, there are nevertheless many instances where a lender's coverage remains deficient, which can result in the lender self-insuring part or even all of the title insurance risk.

The Standard Alta Title Insurance Policy

The title insurance policies in use (with minimum variation) throughout most of the U.S. are American Land Title Association (ALTA) forms of policies. The basic lender's policy form works very well and offers adequate coverage for a plain-vanilla mortgage loan, which would include:

* A fixed rate and amortization.

* One mortgage securing one property.

* No recorded restrictions against the property.

* A new survey of the property in the file.

Frequently, of course, loans are not that simple. Even the most basic loan often includes such terms as variable rates, rate swaps, or negative amortization. Collateral may include both real estate and non-real-estate assets as well as multiple properties in multiple states. Conditions and restrictions may be recorded against the property and, in many instances, a new survey is not obtained.

The basic form of title insurance policy will not provide adequate insurance coverage to a lender for loans containing these more complex terms. Therefore, in addition to the standard ALTA policy forms, there are numerous policy endorsements available to modify the lender's policy. Understanding some of the limitations of the standard lender's policy and the availability of endorsements can go a long way in obtaining the proper coverage.

The Title Policy Repayment Limitation

The title insurance policy sets forth very specific terms regarding the insurance and coverage limitations. One of these limitations (1) requires that each dollar of repayment of an insured loan will reduce the coverage under the title insurance policy by a dollar (repayment limitation). For the basic mortgage loan, this provision is entirely consistent with a lender's expectations, as the lender wants to be insured for the outstanding balance of the loan. As the loan balance reduces, the amount of losses that the title policy covers are likewise reduced.

However, the repayment limitation can lead to some rather unexpected and undesirable results for the unwary lender.

Example 1--multiple pay-downs. A revolving credit facility for $1 million is secured by a $1 million mortgage insured with a $1 million title policy. The credit line is fully drawn, paid down, redrawn, and paid down several more times.

Pursuant to the repayment limitation contained in the standard policy form, the policy will terminate upon a cumulative loan repayment of $1 million, regardless of the balance on the loan at that time. The loan may still have a substantial balance and will have a $1 million credit limit. After the borrower has made a total of $1 million in repayments, the mortgage would no longer be title insured unless the policy carries a revolving line of credit endorsement. This endorsement has the effect of overriding the repayment limitation and would keep the policy intact for the life of the credit facility, regardless of how many times the line is drawn upon and paid down.

Example 2--mixed collateral loan. A $5 million term loan is secured with $6 million in non-real-estate collateral and $1 million of real estate encumbered with a mortgage title insured for $1 million.

As a result of the repayment limitation, the policy terminates upon the repayment by the borrower of $1 million, even though the loan balance would still be $4 million after that repayment. To avoid this result, the policy would need to be endorsed with a last dollar endorsement. The effect of this endorsement is to override the repayment limitation so that the reduction in the policy coverage amount does not take effect until the loan is paid down to a balance of $1 million (the "last" $1 million). Only then would the policy liability limit begin to be reduced by further repayments of the loan.

Other Important Endorsements

There are many other endorsements available to enhance the lender's coverage under the standard ALTA title insurance policy. Following are five that may be considered particularly important.

Nonviolation of conditions, covenants, restrictions. This is often available in the form of an ALTA 9, although some states will have similar endorsements available. In its simplest form, this type of endorsement insures against present violations of any existing covenants, conditions, or restrictions that are set forth on Schedule B-II of the title commitment and further insures against any future violation resulting in the loss of title to the borrower's property.

Survey coverage exception removal or endorsement. The standard ALTA policy excludes from coverage any matters that would be disclosed if a property survey were completed. In many states, the lender can request that this exception be removed or insured over by endorsement, even if no survey is being obtained.