The lender who successfully bids at sheriff sale and takes title to the property becomes the owner. At that point the loan policy in a way converts to an owner policy for the benefit of the lender, now owner.
Up until that point the function of the loan policy is to protect the lender's lien viability and position.
I have a good example on my desk. Yesterday I spoke with a mortgage lender who has a $90,000 mortgage against the property I am hoping to insure. Here's the weird thing about this transaction. The parties have informed us that a short sale is pending. When I examined title, I noticed that the sale price is only $5000.00 and I thought "What the hey?" Then I noticed that the $90,000 mortgage is in second position. YOI.....
So when I spoke with this lender, she confirmed that yes they were agreeing to a $5000 short sale - all proceeds to them - and I asked if she had an agreement with the lender in first position.
After a long pause, she said NO, they are in first. To which I replied, well your foreclosure attorney agrees that they have a valid lien because they were served in the now forestalled foreclosure action.
She immedately recognized a "title problem" and said she'll get back to me.
It's hard to say whether they really knew about the first mortgage or not. That might be why they agreed to such a small amount in the short sale. If they had gone to foreclosure they'd have to pay the first mortgage holder off and maybe the property isn't worth so much.
They might have been hoping that the buyer - being a cash buyer -would forego professional title work and not find the first mortgage at all. It wouldn't have been this lender's problem. All they are doing is negotiating a reduced payoff. If the buyer had proceeded to close without finding the first mortgage, he's have been stuck with it or at least with a claim against the seller and lots of luck there....
I think I've kinda wondered off the subject but you can see how title issues work their way through a foreclosure or short sale process.
Be smart. Buy title insurance from a competent provider.
Hmmmm I wonder if that lender would have a claim against their loan policy that would net them a whole lot more than the short sale.....afterall I bet they are insured in first position.