Mortgagee vs. mortgagor
Let’s warm up to the mortgagee clause concept with a little who’s who in legal lingo. The mortgagee is the loan provider lending the funds and the mortgagor is the borrower receiving them (probably you in this case).
As a mortgagor, you offer up the title of your property as collateral when you take out a loan. That means if you can’t make the payments and end up defaulting on your loan, the mortgagee can foreclose on your home and sell it to make up the money you haven’t paid back. But if the property were damaged or destroyed and is in no shape to sell, how would the lender recoup their costs? That’s where the mortgagee clause comes to the lender’s rescue.
The mortgagee clause is an agreement between your homeowners insurance company and your lender that guarantees a payout to the lender if the property is damaged or destroyed. Most lenders will require you to get a homeowners insurance policy with a mortgagee clause baked in.
Understanding the mortgagee clause
When you think of homeowners insurance, it’s natural to think of the financial protection that covers you, the homeowner, just in case your property gets damaged. Lenders can piggyback on that protection by including a mortgagee clause in your insurance policy.
The mortgagee clause is an agreement between your homeowners insurance company and your lender that guarantees a payout to the lender if the property is damaged or destroyed. Most lenders will require you to get a homeowners insurance policy with a mortgagee clause baked in.
Rest assured, the mortgagee clause is in your best interest, too. This layer of security makes lending less risky for banks and financial institutions, so borrowers like you can get a big enough loan to afford the perfect home.
Pro Tip
If you get a notification that your mortgage lender has changed, you should call the lender to make sure the mortgagee clause on the insurance policy was assigned to the new lender.
How a mortgagee clause works
If you have homeowners insurance with a mortgagee clause, both you and your lender are financially protected if your home is destroyed by a covered claim such as:
- Fire and smoke
- Wind and hail
- Lightning strikes
- Theft or vandalism
- Personal liability if someone is injured on your property
Let’s hope none of this happens, but if it does, your insurance company will swoop in to assess the damage, determine the payouts and settle up with you and your lender.
Your lender comes first in the deal. They would be compensated for up to your remaining loan balance—enough to afford the repairs that would restore the property to its pre-damaged condition. You’d come next, receiving a payout up to the amount of equity you have in the home and your mortgage debt would be wiped clean.
Remember, the lender is also protected in the event the insurance company voids your policy due to intentional damage. The mortgagee clause would make sure your lender would still be compensated for the funds they lent you.
Protecting your assets
Fingers crossed you never have to make a claim, but we’ll look at a mortgagee clause example to help you understand how things might shake out in real life.
Example of mortgagee clause
Let’s pretend you buy a home for $500,000 with a $100,000 down payment, which makes your mortgage $400,000. You buy a $500,000 homeowners insurance policy to cover the total value of the home with a mortgagee clause in place.
Let’s say the home is destroyed by a fire right after you bought it. In this scenario, the insurance company would give your lender $400,000 to cover your remaining mortgage debt and pay you $100,000 to replace the home equity you lost.
How to obtain a mortgagee clause
This part is pretty smooth sailing. Before you can close on a home, most lenders ask you to secure a homeowners insurance policy that includes a mortgagee clause. You’ll have to pick a homeowners insurance company and ask that they add a mortgagee clause to your policy. The insurance company will need your lender’s details and your loan number to make things official.
Pro Tip
If a mortgagee clause isn’t required by your lender, you may want to ask the lender to add one to your contract. If any bad luck were to hit your property, you’d want the insurer—not your wallet—to cover the lender’s losses.
Components of a mortgagee clause
If you don’t speak legal, we’re happy to be your translator. Here are some new terms you might stumble across in the mortgagee clause.
Lender protections
Lender protections are the meat and potatoes of the mortgagee clause: the part that shields the lender from financial loss if the property is damaged or destroyed. These protections ensure the lender will recoup their losses from the insurance company, even if the mortgagor deliberately damages the property themselves.
Loss payee
Here’s an easy one—this is just another word for the mortgagee that stands to receive the insurance company’s reimbursement. You might also hear mortgagee clauses referred to as “loss payee clauses.”
ISAOA
ISAOA stands for “its successors and/or assigns.” This enables your lender to hand over their rights to another bank or financial institution. It comes into play if your lender decides to sell your loan on the secondary mortgage market. Not to worry, this is a common practice that helps lenders free up money to issue more loans. This will have little effect on you as the borrower—you’ll continue to deal with your original lender to manage the loan.
ATIMA
The sidekick to ISAOA is ATIMA, meaning “as their interests may appear.” This lets the lender extend the insurance policy to third-party groups they do business with, even if they aren’t specifically named in the contract. So, if your lender sells the loan to a third party, they’ll also be shielded from financial loss.
