Your Home Is Not Your Castle If You Have A Mortgage: Lenders Use Deed of Trust to Interfere With Your Property Loss

In response to one of my recent blogs regarding the December tornado losses in Dallas/Fort Worth, my friend Curtis Hordge asked a follow up question. Apparently some homeowners in DFW are being told by their mortgage company that the mortgage company will keep all insurance proceeds and use the money to pay down on the home loan. Can they do that? As with many question of law, the answer is that it depends. It depends on what your Deed of Trust says. When you buy a house and go to the title company to sign all the papers, one of the documents you sign is a Deed of Trust. The Deed of Trust has many functions, but mainly, it is like a rule book setting out the rights and duties of the borrower and lender. The Deed of Trust will have a section entitled “Property Insurance” or something similar. That provision sets out the homeowner’s duty to buy and maintain property insurance on the home with an insurance company and with policy limits approved by the lender. The provision also sets out what will be done with insurance proceeds received by the homeowner after a loss. I suppose there are as many forms of Deeds of Trust as there are lawyers drafting them, but I pulled two examples to demonstrate how intrusive (and frankly unfair) they can be.

The first is example is from a Texas Freddie Mac Deed of Trust form. I think Freddie Mac is in conservatorship, but I know this form is still used on some loans.

Unless Lender and Borrower otherwise agree in writing, any insurance proceeds, whether or not the underlying insurance was required by Lender, 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 to ensure the work has been completed to Lender’s satisfaction, provided that such inspection shall be undertaken promptly. 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...Fees for public adjusters, or other third parties, retained by Borrower shall not be paid out of the insurance proceeds and shall be the sole obligation of Borrower. If the restoration or repair is not economically feasible or Lender’s security would be lessened, the insurance proceeds shall be applied to the sums secured by this Security Instrument, whether or not then due, with the excess, if any, paid to Borrower.

Therefore, under the Freddie Mac model, the lender gets to unilaterally decide if repair is economically feasible, whatever that means, and if so, will allow you to use the insurance proceeds (you paid for) to fix your home. Nice of them isn’t it? Along the way, the Freddie Mac model interferes with your right to hire and contract with public insurance adjusters or lawyers to help you get your insurance proceeds, because public insurance adjusters and attorneys usually get paid a percentage fee out of the insurance proceeds and the Freddie Mac Deed of Trust forbids public insurance adjusters and attorneys from being paid out of the insurance proceeds. I will leave for another day whether that provision is enforceable, but right now I can tell you that it is danged unfair.

The next example I found was from the State Bar of Texas.

Lender may apply any proceeds received under the property insurance policies covering the Property either to reduce the Obligation or to repair or replace damaged or destroyed improvements covered by the policy. If the Property is Grantor’s primary residence and Lender reasonably determines that repairs to the improvements are economically feasible, Lender will make the insurance proceeds available to Grantor for repairs.

Here the lender gets to decide whether to use your insurance proceeds to pay down on the loan or to make repairs. The lender can keep your proceeds and not allow them to be used to repair your home if the lender unilaterally determines that the repairs are not economically feasible. What the heck does economically feasible mean? Doesn’t this sound like something out of a George Orwell book? I can guarantee that you and the lender will have different opinions about what is or is not economically feasible.

In the end you need to look at your Deed of Trust and see what it says about insurance proceeds. I would love to challenge a case where a house is repairable and the lender says it is not. I would also love to challenge a Freddie Mac style Deed of Trust that says the public insurance adjuster and attorney cannot be paid out of insurance proceeds.

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Comments (3) Read through and enter the discussion with the form at the end
Ron Reitz - January 29, 2016 3:57 PM

The most widely used Deed of Trust is the Freddie Mac version. Also, lenders typically determine the "economic feasibility" based upon whether the loan is in default or not. If its not in default then they are likely to release the proceeds and permit repairs. If the loan is delinquent, then they most likely will not permit repairs.

Roger Poe - January 29, 2016 10:01 PM

Ummm..Seems like insurance proceeds should be used to bring a property back to a financial value that makes it worth what a policyholder is paying a lender for.

If a lender keeps the money required to bring a property back to it's pre-loss value, should they be required to reappraise the property value..and lower the mortgage payment accordingly?

If a lender keeps the repair money, do they force an insured into a financial catch-22 position to not be able to bring the property back to a condition that insurers will underwrite?

If insurers will not insure the damaged property, can a lender then call in the loan? Foreclose. Keep the equity value. And then resell the property?

Wayne Frazier - January 31, 2016 11:57 AM

Great article Patrick.

Some States are Deed of Trust (DOT) States and others are Mortgage States. The documents are similar in their effect but are different. Both are a means for the lenders to secure their loan with the property being pledged as collateral. The DOT has 3 parties involved, the borrower, the lender and a trustee, where the Mortgage only has the borrower and lender on the document. The other difference is the judicial process for taking back the property (collateral) in the event of default on the loan. Just a little insight for those that don't know.

I personally haven't ran into an instance where a Mortgage Company / Lender refused to allow the insurance monies to be used for repairs but I have been involved in claims where they make it ridiculously complicated. Especially if the insured wants to do repairs themselves.

The most fascinating part of the entire process to me is the overwhelming incompetency of the lenders inspections process and the incessant delays with releasing the draws / monies. I have yet to see anyone inspect the property for a draw release that I believe was qualified to do such an inspection. I once had a lender that fought me on and had absolutely no clue about the repairs process. We finally were able to move forward with repairs, we reached the point of needing the next draw and who does the inspection? The banker The funny thing is that he inspected the repairs / property when nobody was there and signed off as the job being completed when it clearly wasn't. The banker then released all remaining funds that they had in escrow. A colossal waste of time and un-necessary delays in starting the repair work due to the lenders incompetence.

Patrick, on to your final point about challenging the Freddie Mac / Fannie Mae Deed of Trust that says that a Public Adjuster and Attorney CANNOT be paid out of the insurance settlement monies.

I would love to see you litigate this.

The verbiage on the Freddie Mac / Fannie Mae Uniform Document 3021 1/01 states "Fees for Public Adjusters, or other Third Parties, retained by Borrower shall not be paid out of the insurance proceeds and shall be the sole obligation of the Borrower." This is clearly a terribly written inclusion as "other Third Parties" would include Contractors as well as anyone else for that matter. This is where my money would be placed on a lawsuit. Additionally, I see it as of no consequence as to whom is being paid out of the proceeds AS LONG AS the repairs are being sufficiently and properly done to restore the collateralized property to the point that the lien holders security is no linger in jeopardy.

What say you?

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