The question is about a house with a mortgage that burns down. There is full fire insurance coverage, so the insurance covers the mortgage and more. Issue is that you’re planning on rebuilding the house, at which point you’ll need another mortgage, and since the time of the current mortgage rates have increased significantly.
So it would be very much in your interest to keep making the payments on the current mortgage while you rebuild the house, at which point the mortgage would attach itself to the new structure. OTOH, the mortgage company is not going to be keen on losing their collateral, which is now severely devalued.
But possibly you could put the amount of the principal into some sort of escrow, so that the mortgage company has their collateral, and you would gradually withdraw the funds to pay for the rebuilding as the value of the land grows with that rebuilding.
[It also occured to me that the mere decrease in value of a property is not enough to trigger the termination of the loan, which is why so many owners are currently underwater, but I would have to imagine that there are clauses in the mortgage contract for events like fires.]
The insurance covers the value of house, not the mortgage. It is your money to use as you see fit, though ideally it is meant to rebuild. However, You could use that money to go on a year long cruise, but still be liable for the mortgage.
The fire does not itself void the mortgage. You must keep paying, though the insurance allows you to rebuild so that you are not taking a major loss by paying for a no-longer extent house. Similar to buying a small house with a mortgage and tearing it down to build a bigger house…
The mortgage company isn’t going to be interested in retaining a collateral interest in a non-existent dwelling. When your insurance company writes you a check, it’ll usually be made out to you and your mortgage company, and the mortgage contract probably requires you to repay the balance from the insurance proceeds if the house is totaled.
In some cases the insurance company may pay the mortgage company directly without even telling you. Any balance is yours to keep.
Once the original mortgage is paid off you can get a construction loan which is secured by the new dwelling and land.
A fire or total damage to a structure does not make the loan go away. If you choose not to rebuild you still owe that money to the mortgage company.
I have read that if you choose not to rebuild some policies will pay off the mortgage but it all depends on your policy.
I think you guys misunderstand the question. He isn’t trying to get out of paying anything. Basically, say I owe $300K at 3% and my house burns down. I could take the check from the insurance company, pay off my mortgage, and then go borrow another $whatever to rebuild my new house. But if I now have to borrow $whatever at 5%, well, that sucks. So I would rather keep making payments on an empty lot and use the check from the insurance company to rebuild my house. After a year, the mortgage holder is no worse off: my house is rebuilt, the collateral is reestablished. The question is whether they would give me that year, or if they can contractually force me to pay them off once the house is gone.
As long as you are paying them - I don’t think they have grounds to force you to pay off the mortgage early. I could be wrong - I did read all the fine print on mine, but don’t remember it all.
The OP is asking important questions. And the place to get answers is from the mortgage company and the insurance company. From their perspective, this stuff happens all the time, and it should be very easy for them to answer these questions.
It may also depend on the exact terms of the insurance and the mortgage. Again, they’ll answer it a lot faster and more accurately than we can.
By comparison, suppose your car gets totalled in an accident. Sometimes the auto insurance will simply pay the finance company whatever they want, and you are cleanly out of the picture, with no debt or profit. In other cases, the insurance will pay the car’s value, and you either pay the shortfall or keep the difference.
Your first phone call should be to your insurance company.
While we see what the borrower could get out of this arrangement, why would the mortgage company be willing to go along–they would be getting below market interest from the mortgage–rather than being repaid and being able to re-loan the funds at higher rates. And I don’t see the insurance company going along without agreement from the mortgage company–as this could turn out to be a scam and the insurance company having to repay a second time–this time to the mortgage company.
They do have grounds to force a payoff of the mortgage.
Imagine this scenario: Your house burns down, but you continue to make mortgage payments on it for a year. During that time, you lose your job and default on the mortgage. So the bank goes to foreclose on your home, only to discover that it now consists of a plot of land and a pile of rubble. The bank was counting on having the collateral available in the case of a default, but now they basically just have unimproved land.
If you were a mortgage company, would you want to go along with this? Nope. That’s why lenders require homeowners insurance and mandatory payoff clauses - they don’t want to be in the position of having a loan on the books secured by an ash-heap.
It’s possible that you’re under the impression that my house just burned down and I need the answer for this reason. This is thankfully not the case.
This is just some idle speculation.
We are only now slowly emerging from a period of abnormally low mortgage rates, and it’s possible that the rate could be very significantly higher in a few years, especially if inflation picks up as some people think it might. If that’s the case, then - if in fact you can’t hold onto the low fixed rate mortgage - you could take a very serious loss in the event of a fire.
To put some numbers on it: imagine you borrow $300K at 3.375%, 30 year fixed rate (a reasonable rate as of about 1 year ago). Your interest+ principal payments are $1,326.29 per month. 5 years later, you’ve amortized a bunch, but still owe $268,509 withh 25 years remaining. Now the house burns down and the insurance company pays off the mortgage. You need a new loan but rates have gone up, and now a 25 year fixed rate mortgage (assuming such exist) is 6.00%. The monthly payments on $268,509 over 25 years is $1,730 per month, over $400 a month more than your prior payments.
Or, another way of looking at it, is that while you owed $268,509 in principal, the rising interest rates meant that that loan was actually worth a lot less than $268,509. Specifically, the present value of $1,326.29 a month for 300 months discounted at 6.00% annually is worth $205,849. When you switch to a 6.00% loan for that same amount, the value goes back up to the full principal amount, a loss of over $62K.
That’s a lot of money to lose, and you would think there would be a way of protection against that loss.
But it seems to me that in principle, in the scenario you’ve described, the main risk to the bank lies in the fluctuating interest rates. The fact that the house burnt down at one particular point in that fluctuation is almost incidental.
Absolutely. And I think their protection lies in getting good statisticians and economists to figure the best interest rates and such. The simplest answer to your question, I think might be: This is why a 2-year fixed rate mortgage is so much cheaper than a 30-year fixed rate mortgage; when the bank takes a bigger risk, they need to charge you more, and when you take the bigger risk, they’re willing to charge you less.
I just dug out the deed of trust on my mortgage. It says that in event of a loss, the insurance company will pay the lender directly; not me, and not us jointly. And it’s the lender’s option to either apply the insurance proceeds to the outstanding balance on the mortgage, or to spend it to repair the house. I would expect that repairing the house and continuing the same mortgage would be the normal option, but it’s between you and your lender. Taking the money and going on a cruise while just keeping up your monthly payments isn’t an option.
My mortgage is a little more pro-borrower than Twoflowers:
“In the event of loss, Borrower shall give prompt notice to the insurance carrier and Lender. Lender may make proof of loss if not made promptly by Borrower. Unless Lender and Borrower otherwise agree in writing, any insurance proceeds shall be applied to restoration or repair of the Property, if the restoration or repair is economically feasible and Lender’s security is not lessened.”
Further down:
“During such repair and restoration period, Lender shall have the right to hold such insurance proceeds until Lender has had an opportunity to inspect the Property to ensure the work has been completed to Lender’s satisfaction.”
and:
“If the restoration or repair is not economically feasible or Lender’s security would be lessened, the insurance proceeds shall be applied to the sums secured by this Security Instrument, whether or not then due, with the excess, if any, paid to the borrower.”
So the bank gets to hold on to the insurance money while repairs are ongoing, but unless I agree, or they prove it’s not feasible to rebuild/repair, they have to let me rebuild.
For some reason you keep talking about the risk to the bank. I’m not talking about the risk to the bank. I’m talking about the risk to the borrower.
The reason you locked in a 30 year fixed rate at the right time is to take advantage of the low rates if rates rise in the future. If this actually happens and things work out for, then you make a lot of money. You can lose all this gain overnight if the house burns down at a high interest time and you can’t keep the old loan.
I’m not worried about the bank. Partially this is because I happen to not be a bank, but partially because the bank does a lot of financial analysis and has a large number of loans at various rates and because they probably do a lot of hedging to protect themselves against a high interest scenario.
Banks are (mostly) free to lend money on the terms they choose. But a fundamental principle behind a mortgage is that, should repayment not happen as promised, the lender has at all times legal right to seize and sell property sufficient to cover the money owed.
So it would be a strange mortgage that did not include terms that preserve the lender’s rights in case of fire or other catastrophe. These would naturally include provisions to guarantee that insurance coverage in in force, and to specify how insurance payments are to be distributed.
I’m guessing it would be most unusual for a mortgage to include terms that allow what the OP suggests. It’s hard to say what advantage a bank would see to this.
Well, like Xema wrote, it is the bank that dictates the terms of the loan. The only thing the borrower gets to choose is whether or not he likes those terms, i.e., whether or not to apply for such a loan.
But in any case, I’ve always perceived a see-saw effect between the bank’s risk and the borrower’s risk: At any given moment, if one is higher, the other is inevitably lower.
