Following the Money - The Chaotic Kerfuffle When Insurance Proceeds Simultaneously are the Only Rebuild Funds and the Only Mortgage Collateral

25 Pages Posted: 24 Sep 2010

Date Written: Spring 2010

Abstract

One of the recurring and yet repetitively unanticipated challenges is the tug of war between homeowners and their mortgage lender/mortgage service over money. A standard condition of mortgages in the United States is that the borrower must have casualty insurance protecting not just the borrower, but also the bank. When the necessity arises to rebuild the home, the same pot of money - the insurance proceeds - is what the homeowner needs to pay a contractor and what the bank needs to protect its loan until the house is rebuilt. This article sorts out the legal validity to each party’s position. The issues reduce to six questions: 1. Does the bank have rights in all insurance proceeds, just the proceeds insuring the house itself (as opposed to other commonly insured losses, such as the personal belongings in the house or landscaping and other structures external to the house), or something in-between? 2. To what extent does the bank have rights in insurance proceeds if the balance of those funds exceeds the current outstanding principal balance of the mortgage. Does the bank’s rights extend to the overage? 3. As to the funds the bank has rights in, is there a choice available between using the money to rebuild or to pay off/pay down the mortgage, and if there is a choice, does the bank or the homeowner hold the choice? 4. During the time the bank holds whatever money the bank gets to hold, does the money accumulate interest for the benefit of the homeowner? 5. To the extent the money is being used to fund a rebuild, at what interim junctures, if any, must the bank partially release funds? 6. What happens if the bank, while holding the funds, becomes insolvent? This article ends with a proposal to rewrite the standard mortgage covenants to more rationally address these issues.

Keywords: mortgage, collateral, insurance proceeds, rebuild obligation

JEL Classification: K11, K12, K29

Suggested Citation

Klein, Kenneth S., Following the Money - The Chaotic Kerfuffle When Insurance Proceeds Simultaneously are the Only Rebuild Funds and the Only Mortgage Collateral (Spring 2010). California Western Law Review, Vol. 46, No. 305, 2010, Available at SSRN: https://ssrn.com/abstract=1681552

Kenneth S. Klein (Contact Author)

California Western School of Law ( email )

225 Cedar Street
San Diego, CA 92101
United States
619-515-1535 (Phone)

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