When you use your home as collateral for a loan, all lenders involved want that property protected. When you take out a mortgage, the lender is added to your policy as a mortgagee. If you take a second mortgage or home equity loan, the subordinate lender must be added as well. While your primary lien holder has first rights to the proceeds, the secondary lender must be paid as well in the event of extensive damage.
To get a mortgage loan, you must provide proof of homeowner’s insurance. The lender will not close the loan unless it has satisfactory evidence of a policy in the correct amount. This is to protect the lender in the event your home is damaged or destroyed. If such an event occurs, the insurance company will compensate the lender for its interest in the property.
Lenders require that you provide insurance equal to the lesser of the amount of the loan or the replacement cost value (RCV) of your property. The RCV is the amount it will take to rebuild your home from scratch. So if you have a first mortgage of $250,000 and your home’s RCV is $300,000, your first mortgage holder requires $250,000 in insurance. If you were to get a second mortgage in the amount of $25,000, you must increase your coverage to $275,000. If your second mortgage exceeds the RCV, however, you only need to insure to that amount. So, if your total liens equal $305,000, you only need $300,000 in coverage. This scenario is possible because the RCV only details the cost to replace structures, not the value of the whole property, as there is additional value attributable to land.
When you get your first mortgage, you call your insurance company and add the lender’s mortgagee clause. This entails simply putting the lender’s name and address in the appropriate section of the policy. Occasionally, the clause includes the words “its successors and/or assigns,” sometimes abbreviated as “ISAOA.” This just means that the mortgagee will protect the current lender and any future lender who may buy or obtain your loan through a merger or other transaction. When you get a second mortgage, you will add that lender’s information to the policy in the mortgagee section. The information will appear after the first mortgage holder. If your first and second mortgage are with the same lender, it is not necessary to add the lender a second time as long as you have enough coverage for both loans.
If your home sustains damage, you will go through your insurance company’s standard claims process. If and when your claim is approved, the insurance company will cut a check payable to you and both of your lenders. Each lender needs to endorse that check for you to get your money. This means you will have to provide invoices, before and after photos or statements from contractors to prove that the work is complete or in process. If either lender isn’t satisfied, it can delay receipt of the proceeds until you’ve met its requirements.
Carl Carabelli has been writing in various capacities for more than 15 years. He has utilized his creative writing skills to enhance his other ventures such as financial analysis, copywriting and contributing various articles and opinion pieces. Carabelli earned a bachelor's degree in communications from Seton Hall and has worked in banking, notably commercial lending, since 2001.