Why is that and why would your lender be concerned about lien priority?
Lien priority is the child of a multiple lien scenario. When a property has more than one lien recorded against it, who out of those lienors has the right to foreclose on the property? Additionally, if the lienor does successfully foreclose on that property, what happens to the other liens? Do they survive the foreclosure, or do they get wiped out and eliminated from the property?
Well, it’s a matter of the lien’s priority (for the most part). Now, there are A LOT of nuances to this rule when you get into sticky matters of foreclosing on liens and mortgages (which is why you should always engage a practiced real estate attorney if you are embroiled in such a situation), but the general rule of thumb is that the lien that is recorded against a property first in date in time, has priority or is greater in importance or power that those that are recorded in date and time after that lien.
How is this of relevance to loan title insurance? Unlike an owner’s title insurance policy which indemnifies the buyer (new owner) from any loss or damage relating to the buyer’s ownership of the fee simple real property, a loan title insurance policy indemnifies the lender of any loss or damage the lender could sustain as a result of the lien of their mortgage not being the first priority lien on the property.
To further clarify, I give you the following example. Let’s say, “Joe Smith” decides to refinance his mortgage. His current mortgage is paid off and satisfied by his new lender, and his new lender records a new mortgage on June 15th. Prior to that, on June 1st, Joe Smith’s contractor, who has been doing remodeling work on the property, records a lien against Joe’s property. Joe is mad at his contractor and refuses to pay him, so his contractor starts to foreclose against the property.
If Joe’s contractor is successful in foreclosing on the property in court (i.e. he properly notices the lender of his foreclosure action, along with successfully being able to defend against several defenses that a lender may try to raise, etc., etc., etc.), because Joe’s contractor has priority in lien over the recorded mortgage by virtue of his lien being recorded in date and time prior to the mortgage, Joe’s contractor would acquire title to the property free and clear of the mortgage – in other words, totally wiping out the mortgage.
Granted, I have intentionally made the foregoing scenario particularly grandiose to make a point, but things like this do happen. In such a scenario, the loan title insurance policy would protect and indemnify the lender for any loss or damage the lender could sustain as a result of their mortgage being wiped out. In other words, the title insurance underwriter would be required to pay out to the lender the amount of money the lender lost as a result of that mortgage being wiped out. The title insurance underwriter would also be required to represent and defend the lender in court. And this is why ALL lenders require you pay for a loan title insurance policy if you are borrowing money from them to finance the purchase of any property, including refinances and home equity credit lines.