Can Mortgage Lenders Hold Your Insurance Money Hostage?

If your home has been seriously damaged or destroyed, your insurance company will release a check made out to both you and your mortgage lender to pay for the necessary repairs.

"Lenders have a substantial investment in the property, sometimes more than the homeowner, especially if the homeowner has made a small down payment," says Michael Barry, vice president of media relations for the Insurance Information Institute in New York City. Mortgage lenders have an equal right to the insurance check to ensure repairs are made, says Barry.

Yet, while Michael Northagen, vice president with Wells Fargo Home Mortgage in Minneapolis, Minn., agrees, saying "the desire of the [mortgage] lender is always to have repairs made to a property," a consumer advocacy group has come out and said otherwise.

A small number of homeowners who lost their homes last year to the wildfires in Bastrop, Texas, reported that their mortgage lenders made them pay down or pay off their mortgage balance with insurance money, instead of applying the funds towards rebuilding.

Insurance money used to pay down mortgages

According to United Policyholders, a consumer advocacy group for insurance customers based in San Francisco, approximately one-third of the homeowners who responded to the group's post-disaster survey said their lender wanted some or all of their insurance money to be used to reduce their mortgage balance before releasing funds for rebuilding.

"We're continuing to monitor these complaints and are working with the Texas Attorney General's investigation," says Amy Bach, executive director of United Policyholders. "Three homeowners gave us additional information and all three said they were up-to-date on their mortgage payments."

Bach says one of the homeowners received the remaining balance of the insurance proceeds after her loan balance was paid down, but the other two had their entire insurance check applied to their mortgage. The homes of all three were completely destroyed.