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What is a Mortgagee Clause?

What is a mortgagee clause?

A mortgagee clause typically is a provision included in a property insurance policy protecting the mortgagee (lender) from financial loss in the event mortgaged property is damaged -- physical or otherwise. Put another way, a mortgage clause is insurance coverage between the lender and property insurance company that protects the lender and their interest in the property. Most commonly this protects lenders downside when there is physical damage done to the property and it was not initially reflected in the valuation of the property. This clause is often added to homeowners insurance policy (and increases its costs for the homeowner) and is required by mortgage lender to be able to extend a mortgage loan.

In other words, if the property suffers damage, the insurer agrees to financially compensate the mortgagee for their portion of the loss. This is a risk reducing mechanism that enables a vibrant and hyper active lending system which makes it easier for borrower to get a loan, for mortgage originators to function and underwrite such loans and for mortgage investors to repurchase packaged loans in the secondary markets. More on these mechanics below...

Protection for the lender helps the lending system function

The main purpose of the clause is to provide protection to the mortgage lender so their returns on extending a loan for the property is protected in case of substantial damaged or even destroyed. This mechanism allows for shifting of risk from mortgage lender to the insurer, so in case of a cataclysmic event the financial burden is split, which allows for mortgage lenders to extend far more loans to the buyers, allowing more families to move into their homes and enjoy benefits of home ownership. Risk is an important consideration for lenders because thats a useful tool for quantifying their exposure to downside financial risk inherent to their business. Shifting this risk or distributing it between parties within the transaction is an important mechanism that allows creation of new, more sophisticated, and robust systems that allow more access to capital at cheaper rates, allowing everyone who are part of the system to thrive.

Without this mechanism, mortgage lenders would need to be much more risk averse and tightening their lending standards. Which would impact buyers ability to purchase homes. Usually this would mean that buyers would have to put more money down to purchase a property, have higher credit scores, buyer lower valued properties, some areas would be underbanked due to higher perceived risk from the lender, or they would required co-guarantors or co-signers, overall making a loan issuance a much harder process for the borrower.

Protection of the clause doesn't just protect the original lender

The protection granted by the clause doesn't just protect the original mortgage lender. The clause includes ISAOA, or "It's success and/or assigns" term, sometimes written as "successors and or assigns", which means that the insurance protection extends or grants continuing to any financial institution that may repurchase the mortgage loan from the original loan issuer. This is done because, given how the current mortgage loan industry is structured, most commonly, originator of the loan, the first company that issues doesn't hold it to maturity, for the whole 30 year or 15 year term. Instead they package many such loans together into whats called a vintage and sell them to investors that do hold them for 15 to 30 years in order to collect the coupon payments.

These investors also want to be protected from potential damage to the property under home owners insurance for the duration of the loan, which is often substantial. If this extension under ISAOA didn't exists, this secondary market would evaporate overnight, and originators (first issuer of the load would have to hold them until maturity), which would cascade into much stricter rules on original issuance due to much higher risk they would bear, ultimately making it significantly harder for buyers to get a loan.

The protection of the clause often covers not only originator (original mortgage lender), mortgage investor (buyer of mortgage loan packages from the original lender) but also to any company that also works with already protected party. For example, if there are some subcontractor, rental equipment operators, or vendors working on the property and their equipment gets damaged while they are doing anything for the insured parties (home owner or their lender), the ATIMA protection kicks in and covers them under the mortgagee clause, leaving the insurance on the hook instead of homeowner or the lender, making them a loss payee instead of the lender or homeowner.

Once again, this is done to further reduce risk for the lender so the whole lending system can continue issuing loans and make insurers deal with actual, often physical risks of home ownership, while lenders are only exposed to the risks carried by the personal profile of the homeowner, such as their personal ability to pay down the loan for its duration.

How to add a mortgagee clause

If you are a private lender providing a private loan to a real estate buyer (borrower), you can have the borrower contact their property insurer to add a mortgagee clause with you as the mortgagee. Almost all home insurance companies have experience with adding these clauses because any government backed mortgage loan must include such a clause to make it count as a standard loan that can be packaged or securitized into vintage which then can be resold in secondary markets for investors to hold until maturity.

Here is a mortgagee clause for an OfferMarket single family rental property that is insured by OfferMarket Insurance:

OfferMarket Capital LLC ISAOA/ATIMA
627 S Hanover St
Baltimore, MD 21230

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