What Happens to the Mortgage When Your House Burns Down

If your house goes up in flames, does your obligation to pay your mortgage go with it?

Borrowers are bound by the promissory note they sign at the closing of a home purchase or refinance to make monthly mortgage payments. Even the total loss of the mortgaged property doesn’t relieve borrowers of this obligation. A mortgage also requires the borrower to give prompt notice to both the lender and the insurance carrier in the event of a loss.

“Lenders want to help, and they can be very flexible,” says Mike Zarro, executive vice president of mortgage operations at SunTrust Mortgage in Richmond, Va. “They have procedures and programs in place to help clients transition from a disaster back into normalcy.” Lenders may suspend mortgage installments or late payments for a limited period or even stop foreclosure activity altogether, particularly in areas subject to a federal disaster declaration. But, Mr. Zarro adds, “at the end of the day, the obligation to continue paying the mortgage still exists.”

A standard Fannie Mae or Freddie Mac mortgage form—also used for most jumbo loans, Mr. Zarro says—requires the borrower to repair or restore the property, if economically feasible, unless the lender and borrower otherwise agree in writing. That means that borrowers who walk away from their home in the event of a casualty or natural disaster run the risk of defaulting on their mortgage. But other options might be available, particularly for those with jumbo mortgages, since the loans are not subject to Fannie Mae and Freddie Mac guidelines.

For borrowers who plan to rebuild, insurance proceeds are generally held in escrow by the lender or loan servicer and disbursed according to a schedule as construction progresses. Sometimes that leads to tension, either between the homeowner and the insurance company, which might dispute the extent of the loss, or between the homeowner and the mortgage lender over the disbursement schedule. An independent adjuster can help smooth things out with the insurance company, and an attorney might be able to help borrowers negotiate with the lender.

A standard homeowners-insurance policy will also cover the replacement of personal belongings as well as additional living expenses if it’s not possible to live in a house that has been extensively damaged, according to Jeanne M. Salvatore, a spokeswoman for the Insurance Information Institute, a trade-industry group.

But jumbo borrowers, or those with substantial savings or low mortgage balances, may opt to pay off the mortgage directly.

“If the client does not want to rebuild or just wants to satisfy the mortgage, they can pay the mortgage in full, and we would release the insurance proceeds back to them,” Mr. Zarro says. “Or, some lenders may allow you to refinance by doing a home-equity loan on the land or what residual structure remains.”

Borrowers who live in developments with homeowners associations may also be required by the association to rebuild the house, as may some local governments.

 | Jan 11, 2017