Lenders: Think You Are Protected by a Mortgage Clause in Your Borrower’s Insurance Policy? Think Again!

Customarily a lender will require evidence (often in the form of an ACORD certificate) that its borrower’s insurance policy includes a “mortgagee” clause or “lenders loss payable” clause. There are good reasons for this requirement. According to the insurance industry, a mortgagee clause grants special protection for the interest of a mortgagee named in the policy, in effect setting up a separate contract between the insurer and the mortgagee. The clause establishes, among other things, that loss to mortgaged property is payable to the mortgagee named in the policy even if the loss is the result of activities of the insured (i.e., the mortgagor/borrower). In other words, even if the mortgagor/borrower was unable to collect on an insurance claim because he caused the loss, his lender could.

In a recent Wisconsin Court of Appeals case, Waterstone Bank v. American Family Insurance Company, the Court interpreted a standard mortgagee clause to not protect the lender when the insurance policy provides no coverage for losses which occur after the property is vacant for 60 or more consecutive days. Although the vacancy was seemingly an act of the borrower/mortgagor and thus covered by the clause, the Court found that while a mortgagee clause gives a lender the same protection the insured would have, it doesn’t expand that coverage. In other words, since the mortgagor/borrower never had coverage for such losses, the lender didn’t have any coverage either.

While the holding in the Waterstone case is legally sound, it will have an impact on real estate lending, especially residential real estate lending. Not all insurance policies will contain the vacancy exclusion. It’s important for every lender to know what a borrower/mortgagor’s insurance policy provides. For example, a policy for a home loan to a Wisconsin “snow bird,” or anyone who leaves home for months at a time, should not contain a vacancy exclusion under any circumstance.

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