Many times, a homeowner or a general contractor is surprised to learn that the mortgage company on a house is able to intercept insurance proceeds on a covered loss and delay payment. The mortgage company might refuse to disburse money until after the construction project is completed, despite the fact that the construction contract requires a deposit and despite the fact that work might require supplements. Or, perhaps even more infuriatingly, the mortgage company may refuse to release funds for seemingly no reason at all other than its own bureaucracy.
In this article, I wanted to comment briefly on why a mortgage company might end up holding an insurance check for repairs to property, what problems this causes, what the process of getting the check released can look like, and some suggested places to look for remedies when the process doesn’t go smoothly.
WHY DOES THE MORTGAGE COMPANY INTERCEPT FUNDS?
The mortgage company’s ability to intercept an insurance payment probably arises from the Deed of Trust. This is a Colorado real property document that a mortgage company files to secure their interest in real property. These Deeds typically include language requiring the homeowner to have insurance on the property and to use insurance proceeds to fix damage. The mortgage company wants to protect their investment.
Some Deeds of Trust may include language that explicitly allows the mortgage company to “hold” insurance proceeds “until the lender has had an opportunity to inspect such Property to ensure that the work has been completed to Lender’s satisfaction” or something similar. Now, this language does not appear in the recent approved standard forms from the Colorado Real Estate Commission. But, that does not mean that you won’t see it. Pretty much every Deed of Trust I’ve come across contains, at a minimum, some language requiring insurance proceeds to be used to repair the property after a loss.
HOW DOES THIS CAUSE PROBLEMS FOR CONSTRUCTION WORK?
What can end up happening, then, is that the mortgage company refuses to release the insurance funds until after all the work is done. This is a big problem if the contractor needs a deposit or progress payments, particularly on bigger projects. It can lead to project delays or unpaid subcontractors that can snowball into larger issues. Or, if the contractor just does the work all in advance, it basically forces the contractor to give a free loan to the mortgage company who enjoys the time value of money. Even worse, sometimes a mortgage company has no particularly good reason for not disbursing funds, but just uses endless requests for documents and forms and bureaucracy with the effect of delaying the process. This can make everyone extremely upset.
WHAT OPTIONS EXIST TO AVOID THIS PROBLEM?
Care should be taken to avoid these problems. Obviously, all situations are unique and fact-dependent, so there is no single solution. But, there are some common ideas to consider.
To begin with, if an insurance company issues a check that requires a mortgage company’s endorsement, it is worth checking the Deed of Trust and see exactly what the mortgage company is allowed to do. Perhaps the mortgage company could be asked to endorse the check first, before other endorsements, so that the mortgage company does not have the ability to deposit the check and thus add more delay when it is asked to re-issue the funds. If the check must be deposited with the mortgage company, the contractor and property owner should make sure they communicate openly about a process to get the money released so that the contract can be performed.
When a mortgage company refuses to disburse and this places the homeowner in breach of a construction contract, this seems contrary to the purposes of the Deed of Trust language. After all, the Deed of Trust probably says that the insurance money must be used to repair and restore the property. That is precisely what the contractor is trying to do. So, if the mortgage company doesn’t agree to pay the contractor, it is might be violating the language in its own Deed of Trust.
DEALING WITH THE MORTGAGE COMPANY
Another point to bear in mind is that, when a large organization such as a mortgage company tells a homeowner or contractor that certain forms are required or certain things must be done before the money is released, this can mean different things. The requirement might be connected to a specific agreement in the Deed of Trust or a specific law, sure. But, often, the requirement is not actually required by contract or by law, and it is simply something the mortgage company has decided it wants to require for its own internal purposes.
The latter institutional requirements are not necessarily binding in the sense that nothing really stops the mortgage company from waiving the requirement. This can come up in situations where, for example, the Deed of Trust does not actually require an inspection and final completion but the mortgage company claims it is their policy to require one anyway before disbursal. Now, the mortgage company may be unwilling to violate its institutional requirements, but the point is that it could if it wanted to do so.
HIRING COUNSEL IS IDEAL
Obviously, hiring an attorney to analyze and help deal with problematic mortgage companies in this situation is ideal. Depending on the situation and the language of the contracts involved, the homeowner and contractor may have more or less power to get the funds released. Or, if the situation is really intractable, the parties may wish to find other ways of getting the work done within the insurance company’s demands. An attorney can help document this.
Above all else, it is important that the homeowner and contractor stay aligned when dealing with this issue as much as possible. If the contractor is not diligent about getting the insurance funds released, or if the customer does not understand that the delay is coming from the mortgage company, bad feelings can develop between the two that can lead to a breakdown and breach accusations. But, if both parties understand in advance how the process works and that everyone is really on the same team concerning getting the property fixed, a better result can be found for all.