Mortgagee clause: Definition and how it works

When you’re obtaining a mortgage, mortgagees (also known as mortgage lenders) put in place certain measures to ensure that the collateral for their investment – your new property – is protected. One such measure is the mortgagee clause, which goes along with your homeowners insurance policy. In this article, you’ll learn more about what a mortgagee clause is and how it can benefit homeowners.

What is a mortgagee clause?

A mortgagee clause is a protective provisional agreement between a mortgagee and a property insurance provider. This clause is meant to protect a mortgagee (usually the lender) if the mortgaged property is damaged. Protections will be geared toward your lender, but they could benefit you as well. A mortgagee clause in your homeowners insurance policy could end up covering costs that could otherwise put you in deeper debt to your lender.

This type of clause requires the insurer to guarantee payouts when any claims covered by the property insurance policy are made.

Mortgagee vs. mortgagor

Since a mortgagee is a mortgage lender, a mortgagor is the borrower. In a real estate transaction, a mortgagee provides a mortgage loan to a home buyer who then offers the title of the property purchased to the mortgagee as collateral.

This means that if a mortgagor is unable to keep up with the monthly mortgage payments and defaults on the loan, the mortgagee can foreclose on the property and sell it to recoup costs.

How does a mortgagee clause work?

Mortgagee clauses are provisions within a borrower’s property insurance policy that stipulate that, in the event of loss or damage, the insurance company makes payments to the mortgagee. In practice, the mortgagee clause ensures that the cost of any losses or damages would be paid to both the homeowner and the lender.

This clause also protects the lender if you intentionally cause damage to the property that leads the insurance provider to cancel the policy. For example, if a homeowner purposefully sets fire to their home in order to collect the insurance payout – an act that would void their insurance policy – the clause protects the mortgagee, ensuring that your lender will still be covered without putting a lien on your property.

Standard mortgagee clause vs. loss payee clause

The standard mortgagee clause and the loss payee clause are both common mortgage clauses that deal with what happens if there is a loss or damage to the property. While the two clauses have some similarities, they differ in a critical area. It’s crucial to understand the difference as it might pertain to your loan.

A loss payee clause (sometimes referred to as an “open” clause) may prevent the mortgagee from collecting any proceeds from the insurance company, if the loss or damage was caused by neglect or default, either by the mortgagee OR the property owner. On the other hand, the standard mortgagee clause (sometimes referred to as a “New York” clause) allows the lender to collect money from the insurance company, as long as they pay any insurance premium if the owner does not.

Why is a mortgagee clause important?

A mortgagee clause is included in a homeowner’s insurance policy that ensures that a lender can also receive payment if there’s a claim on the property. A mortgagee clause can protect both the lender and the borrower, which is why it’s often used as part of the underwriting process.

It’s common that the homeowner is the one who enters into a contract with an insurance company to protect their property. The mortgagee clause also includes the lender or mortgage servicing company as a party to the insurance contract. Since the lender also has an interest in the property (since they put up the loan to purchase it), most lenders will require a mortgagee clause as a condition of approving you for a mortgage.

Where do you find the mortgagee clause?

Many lenders require borrowers to have a mortgagee clause, and it’ll be a part of the loan under their property policy, issued by the homeowners insurance company. Usually the mortgagee clause will be included in the loan documentation you receive at closing. Most lenders require a mortgagee clause to protect their interest in the property. In some cases, it may not be a requirement to get a mortgagee clause. In that situation, if a borrower wants to add a mortgagee clause, they must contact their lender to add the clause to their current contract.

Mortgagee clauses in different types of property insurance

Property insurance includes a few diverse types of policies:

• Homeowners
• Flood
• Earthquake
• Condominium

Homeowners insurance and condo insurance generally cover these types of buildings against loss and damage. Flood and earthquake insurance are specialty policies that cover those specific disasters. They may be required if your property is in an area that is prone to flooding or earthquakes.

Most mortgagees will require enough a mortgagee clause on an insurance policy that covers the mortgagor’s entire property, in order to protect their investment. If a property were damaged while uninsured, the mortgagee might not be able to sell it for enough money to cover the remaining balance of the mortgagor’s loan. In this way, this insurance also protects the mortgagor, who would most likely be held accountable for repaying the difference.

What are the components of a mortgagee clause?

A typical mortgagee clause is made up of sections for different purposes.

Lender protections

This component of a mortgagee clause prevents lenders from financial losses and from taking complete responsibility for a failed loan due to property damage. The mortgagee clause ensures that the insurance company pays the lender if the property is damaged and guarantees that they’ll receive their money even when borrowers are responsible for the destruction of the property.

ISAOA

ISAOA is an acronym found in mortgagee clauses that stands for “its successors and/or assigns.” It’s included in the clause to stipulate that the mortgagee can transfer their rights to another bank or financial institution. This ability to assign rights to another party allows the mortgagee to sell the mortgagor’s loan on the secondary mortgage market.

This may sound like an unusual scenario, but lenders commonly sell borrowers’ loans to secure funds for future loans. This practice has little to no effect on borrowers. Even if a lender sells your loan, they can retain the servicing rights, meaning you still send your payment to them and they’re responsible for maintenance of the escrow account. You can also contact your lender about the loan at any time.

ATIMA

Another acronym commonly found in the mortgagee clause, usually used in conjunction with ISAOA, is ATIMA or “as their interests may appear.” This term is used to extend the insurance policy to include coverage for other business-related parties aligned with the mortgagee.

Its meaning is very similar to ISAOA, as it merely allows the mortgagee to include others under the policy’s protection without having to name them explicitly.

Loss payee

The loss payee in a mortgagee clause is the party entitled to a reimbursement, which in most cases is the mortgagee. This is included in a mortgagee clause to identify who should receive the funds in case of a loss or damage to the property.

The bottom line: Mortgagee clauses are designed to protect both parties

The mortgagee clause is a provision in a property insurance policy that ensures that the insurance company will pay the mortgagee if a covered loss or damage occurs to a mortgagor’s property. The clause protects a mortgagee’s investment in a mortgagor's property. If you’re a mortgagor, it’s vital to have a strong understanding of all the contractual provisions that could have an impact on you and your real estate transaction.

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