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Buying a home (or any other kind of real estate) may be the largest and most expensive purchase you ever make. And for most of us aspiring home buyers, buying a home usually means borrowing money from a lender (read: getting a mortgage).
As you might have already guessed, to get a mortgage loan, you’ll have to do a lot more than politely ask for the money you need.
To ensure that you can afford a home loan, a mortgage lender will look at your finances, credit history and credit score to measure your creditworthiness (think: your reliability to pay back your bills).
Knowing that you can comfortably afford to repay the loan is one way a lender can protect their financial investment in your soon-to-be home. Another way lenders protect themselves from potential financial losses is by requiring that borrowers get homeowners insurance.
The property insurance covers the mortgaged property (aka your home) and its assets in the event of theft, damage or destruction.
Lenders get this assurance in writing by adding a mortgagee clause to a homeowners insurance policy. The clause protects the mortgagee (the lender) from financial losses and requires the insurer to pay the mortgagee any insurance payout if something happens to the property.
Let’s explore how the mortgagee clause works.
Mortgagor or Mortgagee?
Before we dive into the mortgagee clause, it’s important to understand the difference between a mortgagee and a mortgagor.
If you need a loan to buy a home, you’re the mortgagor. The mortgagor is the borrower. When anything pertains to you in the mortgage contract, you will be referred to as the mortgagor.
The mortgagee is the bank or institution that provides the loan for the property purchase. The mortgagee is the lender.
What Are the Mortgagor’s Obligations?
The mortgagor has specific obligations under the mortgagee clause. Under the clause, the mortgagor is required to notify the insurer of any changes in ownership, occupancy or exposure (read: other loans taken out on the home).
The mortgagor is also expected to pay outstanding premiums and dues and submit a signed statement of loss within a specified time frame after any covered incident.
How Does a Mortgagee Clause Work?
A mortgagee clause identifies who has the legal right to financial reimbursement when a home is damaged or destroyed. Until you pay off your mortgage, your lender has the majority stake and financial interest in the property.
The home is the collateral (aka an asset that secures a loan) for the mortgage loan. If the home is damaged or destroyed, the mortgage will expect payment for the destroyed collateral according to the extent of the damage and the unpaid balance on the mortgage loan.
Let’s take a look at two scenarios:
Scenario 1: Destruction of property
Let’s say a fire broke out and destroyed a home. We learn that at the time of the fire the owner had an outstanding balance of $550,000 on their mortgage and their insurance policy had a $550,000 payout limit.
In this case, the mortgagee would receive the outstanding $550,000.
Scenario 2: Foreclosure
In July, a mortgage lender delivered a notice of intent to foreclose on a home after several months of missed payments. Then, in August, the home catches fire and burns to the ground.
Even though the lender had already taken possession of the home, the foreclosure notice won’t impact the lender’s right as the mortgagee to collect on the insurance policy. The insurance company would still pay the mortgagee what they’re owed.
When does the mortgagor have the right to collect?
When the property is damaged or destroyed, the mortgagor must submit a claim with the insurance provider. The insurance company works with the mortgagor to appraise the damage, determine a payout amount and coordinate payments to the mortgagee and the mortgagor.
Even if the mortgagor’s insurance policy is not in good standing (missed payments, etc.), the mortgagee can collect on the insurance policy as long as they meet these conditions:
- Pays the outstanding premium the mortgagor hasn’t paid
- Submits proof of loss within 60 days of receiving notice that proof of loss is due
- Notifies the insurer if they become aware of major changes in the property’s occupancy ownership or risk
Can you opt out of a mortgagee clause?
The answer is most likely a big no. It’s highly doubtful a lender will approve your mortgage application if you don’t include a mortgagee clause in your homeowners insurance policy. In most cases, a mortgagee clause must be included to finalize a mortgage loan.
What Are the Components of a Mortgagee Clause?
The standard mortgagee clause typically comes with lots of mortgage-speak. Lucky for you, we’re fluent in mortgage-speak and can easily translate the most common terms you’ll run into.
A mortgagee clause protects the lender’s financial interest in a property and ensures that the lender is paid by the insurance company in the event of property loss or damage.
ISAOA stands for “its successors and/or assigns.” The ISAOA allows the mortgagee to transfer their rights to another bank or financial institution. With ISAOA, the mortgagee can sell mortgagor loans on the secondary mortgage market – it’s a common practice of many banks.
ATIMA stands for “as their interest may appear.” This acronym refers to any other parties the mortgagee does business with that the insurance policy also covers.
A loss payee is a person or party who is entitled to all or some of the insurance payout on a claim. In most cases, the loss payee and the lender are the same.
When you file a claim with your insurance company, you (the mortgagor) fill in the loss payee section with your mortgage lender’s name, address and loan number.
Lender’s loss payee
A lender’s loss payee is similar to a loss payee. Both protect the lender’s right to collect on an insurance claim for a property. The difference between the two types of claims is in the extent of the protection.
Mortgagee Clauses Protect Everyone!
A mortgagee clause is a vital part of the mortgage approval process. TBH, it’ll be tough finding a lender that will approve you for a mortgage loan without a mortgagee clause added to your homeowners insurance policy.
But remember, you and your lender benefit from including that clause.
The clause allows your lender to rest easy knowing that their large financial investment in your home is protected, and it protects the property you worked so hard to finally make your home.
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The Short Version
- If a home is damaged or destroyed, the mortgagee clause ensures that the insurance provider will pay the mortgage lender for any losses
- The acronyms ATIMA (as their interests may appear) and ISAOA (its successors and/or assigns) are commonly used in mortgagee clauses
- Mortgagee refers to the lender, and mortgagor refers to the borrower