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.