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Can Mortgage Lenders Hold Your Insurance Money Hostage?

By all accounts, what has been reported in Texas isn't a common occurrence. Both Northagen and Barry say it would be extremely unusual for a lender to require homeowners to pay down their loan balance with insurance funds before they could make needed repairs, since it is in the lender's best interest to have the property restored. Northagen says this might only occur only if a borrower is seriously delinquent or in foreclosure. Neither Northagen nor Barry has ever heard of this happening to borrowers who are current on their mortgage.

Mortgage lenders and insurance claims

Northagen says that if homeowners haven't contacted their mortgage lender or servicer shortly after their home was damaged, receipt of a check made out to both lender and homeowner should trigger you to act.

"If the insurance claim is less than $15,000 and the loan is current, the servicer will usually endorse the check and release the funds to the homeowner with minimal documentation such as a photo ID and a copy of the insurance adjuster's worksheet," says Northagen. "About 60 percent of the time, this is how claims are handled."

However, Northagen says the other 40 percent are larger than $15,000 and require monitoring by the mortgage lender.

"Typically, for a larger claim, the lender becomes more intimately involved with the repair process," he says. "The lender would need to see the contractor's estimate and a W-9 document for reporting purposes. Under these circumstances the lender would put the insurance funds in escrow after getting the borrower's endorsement and then would release the funds in three installments."

On a $30,000 claim, for example, the first $10,000 would be given to the homeowner to pay the contractor when the claim is first documented, according to Northagen. The lender then pays for an inspection when the work is approximately 50 percent complete and then releases the second installment. The final payment is made after another inspection ensuring that the repair is complete.

Delinquency changes everything

Northagen says that borrowers who are current on their payments should experience the same process regardless of whether their property was entirely destroyed or not. Even borrowers who are in default normally will have their insurance claim handled the same way as long as they are working with the lender on a repayment plan.

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