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06/09/09: Insurance Proceeds May Not Go To Homeowner If Disaster Occurs


By Benny L. Kass

Q: Last year my wife and I purchased a new home. A couple of weeks later, the town where we live was heavily damaged by a tornado, along with strong straight-line winds. Our neighborhood was particularly hard hit with at least two homes totally destroyed. Our house sustained damage as well and we received a fair insurance settlement to make necessary repairs. We have a mortgage, and the insurance check was made out to us and to the mortgage company. We were informed that the lender would only distribute the insurance proceeds after they receive estimates from contractors and itemized lists of the cost of materials and labor.

Do I have any rights in this matter or does the mortgage company have the legal right to hold the check and only distribute it as it deems necessary? It’s a little difficult to get contractors to do repairs when they know they will have to wait on an inspector and then also wait till the lender agrees to send money.

A: You have to read your mortgage document carefully. When you went to settlement, you signed two important legal documents: a promissory note and a deed of trust (also called a mortgage). The latter document contains all of the rights and obligations that you, the borrower have to follow.

For example, if you are late with your monthly payments, you are in default. There are sections in the deed of trust spelling out what your lender can do to you, including calling the entire loan due after proper notice to you or ultimately starting the foreclosure process.

Most consumers when they go to the settlement table do not bother to read the deed of trust. It is lengthy (usually 14 or 15 pages), and legalistic. More importantly, since it is a standard form used by the lender, it is almost impossible to change any of the terms. The lender’s position is usually: “you want my loan, then sign my legal documents”.

One section of the deed of trust is entitled “Property Insurance”. Here is a portion of that long section:

Borrower shall keep the improvements now existing or hereafter erected on the Property insured against loss by fire, hazards … not limited to earthquakes and floods… What Lender requires … can change during the term of the Loan…

In the event of loss, Borrower shall give prompt notice to the insurance carrier and Lender… Unless Lender and Borrower otherwise agree in writing, any insurance proceeds … shall be applied to restoration or repair of the Property, if the restoration or repair is economically feasible and Lender’s security is not lessened. During such repair and restoration period, Lender shall have the right to hold such insurance proceeds until Lender has had an opportunity to inspect such Property… Lender may disburse proceeds for the repairs and restoration in a single payment or in a series of progress payments as the work is completed.

Assuming that your deed of trust contains similar language, there is nothing you can do at this point in time. In fact, I have been involved in situations where the lender flatly refused to pay any contractor, and instead credited the entire insurance check against the outstanding balance of the loan.

I am surprised, however, that contractors are reluctant to go forward with your job. There are a lot of good, licensed contractors who are looking for work, and in your case, the money is literally “in the bank”.

Your contractor should talk with the lender, so as to be satisfied that payment will be made. While it is true that the payments may be disbursed pursuant to a draw schedule (i.e. when the dry wall is done, you will get XX dollars, and another XX dollars when you complete the electrical work), this is not unusual in home improvement contracts. Indeed, I always recommend that homeowners work out a draw schedule, so that the contractor will only get paid as the work outlined in the schedule is completed.

You were fortunate that you had adequate insurance coverage. Unfortunately, not everyone does. And even if you have coverage (which is required by your lender), have you properly prepared for the next disaster.

According to the National Association of Insurance Commissioners, there are several steps you should take immediately:

– inventory everything in your house; with video or digital cameras, this is quite easy to do;

– store copies of your insurance policy with your inventory, but remember to keep them in a safe place, preferably outside of your house.

– does your policy include replacement cost or actual cash value for losses?

– are you in a flood hazard area? Do you have coverage for floods?

– have you discussed your coverage with your insurance agent to make sure that you are not over or under-insured?

(For more information, go to www.naic.org).

The Virginia Department of Emergency Management recently reported that last year, 39 tornadoes struck Virginia, the second highest number ever recorded in a single year. Maryland has also had a number of tornadoes that caused severe property damage.

You must make sure that you are adequate covered – and prepared.

– Boilerplate –