Hi Pamela- I worked on and with many older houses that had this kind of wiring, and also worked for insurance property inspectors to boot. I think you do have a legit claim if you did not know it had knob and tube wiring when you signed the P&S.. If you did not, and the home inspector made you aware, then you have something within the inspection contingency to fall back on.
As far as the mortgage situation, you need a H.O. insurance binder to close on a mortgage.
However, I think that you CAN get a HO policy- you will have to shop around a bit with different companies and you will end up paying more for this policy. All of that is on your lap and the seller really wouldn't care about it.
Best bet is my note on the inspection clause in the P&S.
Hope the seller is willing to talk about it further... Thanks and good luck,