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Homeowners Insurance Claims and the Foreclosure Crisis

posted by Daniel Schwarcz

Prompted by several comments to one of my earlier posts, I've been thinking about situations where a homeowner files an insurance claim for property damage to her home while she is in default on her mortgage.  The general practice, as I understand it, is for insurers to write claim settlement checks out to the mortgagee, rather than the policyholder, in such situations.   This practice is based on a clause in most homeowners policies that "If a mortgagee is named in this policy, any loss payable under Coverage A or B will be paid to the mortgagee and you, as interests appear." 

All of this makes sense.  But, it seems to me that the mortgagee ought to have an obligation to promptly use any insurance proceeds it receives in this manner to fix the underlying property damage.  Failing to do so, and holding on to the insurance proceeds as cash collateral, seems to me to potentially constitute a violation of the mortgagee's obligation of good faith.  Yet according to the commentators referenced above, this is apparently a common practice (though I would be curious about other readers' experiences).  

Here is why it seems to me that mortgagees should be obliged to use insurance proceeds to promptly pay for the underlying insured damage to the home.  Insurance payments for damage to a dwelling are generally meant to restore the underlying property to its undamaged state, or at least to a reasonably usable state (when the policy provides ACV loss settlement).    This produces two benefits: it ensures that the value of the property is not substantially diminished and it ensures that the present occupants of the home can promptly use that home as they did prior to the damage.

The first of these benefits -- preserving the value of the home -- protects both the mortgagee and, to the extent the homeowner has some equity in the home, the homeowner as well.  From this perspective, it may be reasonable for mortgagees to hold on to the insurance proceeds as cash collateral, and only disburse proceeds if there is surplus after the loan is settled.

But the second benefit of insurance -- preserving the capacity of present occupants to use the home as they had prior to a loss -- is solely for the benefit of the mortgagor/policyholder.   And so long as the mortgagee does not have the right to immediately deprive the homeowner of possession, this benefit is both real and potentially valuable.  All this means that when a mortgagee refuses to use insurance proceeds to promptly fix the underlying property, it is depriving the homeowner of the second, use-related, benefit of insurance.

If all of this is right, then maybe insurers should not, in fact, pay claims proceeds to mortgagees when the mortgagor is in default, but they should instead directly pay for the underlying home to be fixed.  This would not only protect the mortgagee's collateral, but it would also protect the policyholder's right to benefit from her insurance through the prompt restoration of her property. 


Comment would be on the Replacement Value and the payment of only 80% of the replacement value in the case of a total loss. As it was explained to me the replacement value of my home is 168000. In reality on my land it could be rebuilt for under 100.

They made me use a worksheet to value it - a standard model. But i could insure it for 80 but in the case of a loss and i rebuilt it at 80 - they would only pay 80% of that.

Where in the world does that fit in?

Over the last couple of years, perhaps the poster child for servicer bad faith in respect of insurance proceeds is that illustrated by the appellate case:

U.S. Bank, N.A., as trustee for J.P. Morgan Acquistion Corp. 2006-FRE2 v. Arthur Spencer et al, Superior Court of New Jersey, Chancery Division, Bergen County, Docket No. BER-F-10591-10, 2011 N.J. Super. Unpub. LEXIS 746, Decided March 22, 2011, Amended March 28, 2011.

Regretably, the NJ Superior Court seems to only leave the unpublished decision Adobe files up for a few weeks. (If I had realized that, I would have downloaded the decision and posted it on Scribd.) But the case can be found on Lexis and LexisOne. It can probably also be found on WestLaw.

We had a brief discussion about this decision at the MS Fraud site at:

Terriffic New Decision of NJ Superior Court: U.S. Bank v. Spencer

The defendant's attorney Gary E Stern weighed in with a few brief comments.

Secured personalized loan A loan secured in opposition to some immovable or movable asset is called a secured mortgage. These loans are easy to get because the lending institutions sense snug although giving them. The reason for their comfort is the collateral you provide.

Attorney Gary E. Stern furnished me a digital copy of the U.S. Bank v. Spencer decision mentioned above, which I have uploaded to Scribd:


Thank you for addressing the issue!

I have several examples, but one homeowner with whom I have had many discussions, has title as a joint tenant in a home that is the subject of a protracted wrongful foreclosure lawsuit with an entity ( a lender) to whom the homeowner has superior title. But the foreclosing entity is named on the homeowners insurance policy.

The home sustained (covered) damage. The insurance company sent an adjuster, prepared an estimate of allowable expenses, approved the repairs, recommended repairmen, etc. The homeowners policy stipulated a $1,000 deductible, and the repairs (not including damage to some personal belongings) were estimated to be about $6,500. Approximately half of that amount was for the replacement of the carpeting.

The homeowner agreed to the insurance company's "approved" repairmen to fix the structural damage, but believed that he could find a better grade of carpeting for the allowable amount. Therefore, he approved the repair work, but he advised the insurance carrier that he would be purchasing the carpeting on his own, and would just get reimbursed after the fact.

In a quite timely manner, the homeowner received a check from the insurance carrier, but the check had been drafted to both homeowner and lender. (The entity with whom the homeowner is involved in ongoing litigation.)

The homeowner contacted the insurance carrier, explained the situation, and followed up by sending copies of the receipts for the carpeting, pad, and installation to the insurance carrier. The insurance carrier apologized, but insisted that it was a state law that any claim over (I think it was $5k or $6k)HAD to be drafted to the lender as well as the homeowner.

The check has not been negotiated because the homeowner cannot get an assurance from the foreclosing entity that they will pass the funds back to the homeowner.

The homeowner is out of pocket a couple of thousand dollars at this point, and the "insurance carrier-approved" repair companies,last I heard, were threatening to sue the homeowner. (I do not know how or if the repair companies' issues ended up being resolved.)

As a post script to this story--the same home sustained roof damage from a hail storm. the homeowner did not even bother reporting it to the insurance carrier, as he knew it would end up the same way. The last I spoke with him, his now leaky roof had begun to cause some mold issues. The homeowner feels as though he has no homeowners insurance, and has nowhere to turn to get homeowners insurance without the involvement of the other party to the lawsuit.

That being said - I should reduce my coverage to the value to rebuild and let the servicer sue me or whatever when after 19 years paying - and now they are escrowing a much HIGHER AMOUNT - increasing pmt 200 a month.

I can see it now. Servicer B says to Insurance A. It only cost 90 to rebuild and we paid for 100. A Says the model said 170 so we cover that or only 80% of the 90 which was the real number.

Makes perfect sense to me

I encountered this scenario several times in practice. The settlement check was invariably made payable jointly to the homeowner and the lender (sometimes also to a public adjuster, but that is another topic.) Mainstream servicers would insist on A) holding the funds, B) applying them first to delinquent payments, and C) disbursing to contractors only on completion of work. Given the generality of both the insurance and mortgage contracts on how claims payments should be made in this scenario I litigated good faith issues several times. One particularly egregious case involved a finance company applying the entire settlement for a destroyed home to pay off the loan and immediately writing a new loan (with subprime points and fees) so the homeowner could rebuild.

My office is litigating a case of this sort after a fire burned our client's home, rendering it uninhabitable and she temporarily moved in with family. The insurer sent payment to the mortgage servicer, who refused to disburse any funds to the homeowner or to pay a contractor to repair the damage. The homeowner engaged contractors and obtained several quotes, but the servicer wouldn't disburse until after the work was performed, and no contractor wanted to take on that risk (and good on them). The servicer simultaneously denied the homeowner for HAMP on the grounds, I kid you not, that she did not reside in the property.

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