What’s a mortgagee clause, and why do you need one?

A mortgage clause lets borrowers secure a loan and buy a home. This provision protects the lender’s investment if the home is damaged or destroyed, reducing financial risk and enhancing credibility. 

This clause is almost always a loan requirement and most home buyers will encounter it during approval, so understanding its purpose and advantages can reduce confusion and streamline the process.

Learn how a mortgagee clause works and how to set one up to manage your home loan confidently.

What’s a mortgagee clause?

A mortgagee clause is a provision in a borrower’s homeowners insurance that protects a lender’s investment. It enshrines the lender’s legal right to receive a payout for their financial interest — the unpaid mortgage balance — if a covered loss occurs. Coverage often includes incidents like fire, theft, and vandalism.

This protection reduces a lender’s risk when providing the large sums of money needed to buy a home, making it a standard part of most home insurance policies. It also entitles them to advance notice from the insurer if the borrower cancels or doesn’t renew the policy. This gives the lender time to contact the home owner and request new coverage.

Mortgagee clauses for insurance ensure the lender is covered even if the homeowner damages the property intentionally. Suppose fire damage turns out to be the result of arson committed by the borrower. The insurance company won’t cover the homeowner’s financial interest (i.e. their equity in the home) but the lender will receive the unpaid mortgage balance just the same.

Roles of the mortgagee vs. mortgagor

Apart from the insurance company, a mortgagee clause has two parties: the mortgagee and the mortgagor. The former means “lender,” and the latter means “borrower.”

The lender provides a mortgage to the borrower, who puts up the property as collateral. Mortgagees need to ensure this collateral retains its value if the borrower defaults or the home is damaged. Mortgagee clauses protect the lender’s investment by compensating them for losses in property value, reducing financial risk.

How does a mortgagee clause work?

A mortgagee clause makes the lender a beneficiary in the borrower’s homeowners insurance and outlines what happens if an insured event causes damage to the mortgaged property. Under this provision, the insurer typically sends funds directly to the mortgagee or generates a joint payment for both the borrower and the lender.

If the damage is fixable, the lender oversees how the homeowner uses the money to repair the property back to its original state to preserve its full value. If the loss is total and the home is a write-off, the insurer pays the lender the remaining mortgage balance and the borrower the amount of their equity in the home.

Example of a mortgagee clause

Imagine a homeowner takes out a mortgage for $400,000 on a $500,000 home, makes a down payment of $100,000, and purchases a homeowners insurance policy covering the entire home’s value. The borrower pays down $50,000 of the mortgage balance over time, giving them a total of $150,000 in equity and a remaining loan balance of $350,000.

Then, the house burns down due to factors beyond the homeowner’s control. Repairs aren’t possible, and it’s a total loss. Once the insurance company approves the claim, the lender receives the full outstanding balance remaining on the mortgage: $350,000. The borrower gets what’s left to recoup their equity: $150,000.

Key components of a mortgagee clause

Most mortgagee clauses have these elements in common:

— Lender protections: The core of this clause is reimbursement for the lender, which ensures the mortgagee will be compensated in the event of property damage.

— ISAOA: Meaning “its successors and/or assigns,” this item allows the lender to transfer the rights granted to them in the mortgagee clause to another financial institution.

— ATIMA: This acronym stands for “as their interests may appear.” It extends the insurance policy to include coverage for other parties connected to the lender’s financial interest in the property, such as loan servicers or investors.

— Loss payee: This field simply shows who receives funds first if a claim is filed and approved. This is usually the lender.

How do you add or update a mortgagee clause?

During the loan approval process, your lender will tell you to purchase homeowners insurance and add a mortgagee clause naming the lender as the beneficiary. This is nearly always a requirement, and often happens in your commitment letter.

Borrowers then supply the lender’s details to their insurance provider, including the legal name of the mortgage company and loan number. The insurer then adds the mortgagee clause to the declarations page, a document summarizing the policy. Borrowers should promptly share this document with the mortgagee as proof of coverage.

If there’s a mistake or your lender’s information changes, you can update the mortgagee clause. The precise steps depend on the policy, so contact your insurer to start the process.

Managing insurance can be stressful, but Better takes care of the little details for you. With Better Cover, you can secure homeowners insurance that already meets your Better Mortgage’s coverage requirements. Our insurance and loan teams work together to provide a seamless, successful close, so you can focus on your move.

...in as little as 3 minutes – no credit impact

Why use a mortgagee clause? Benefits and protections

Reducing lender risk is the core purpose behind mortgagee clauses, and this protection benefits homeowners, too. Without assurance that their collateral is safe, lenders would be much less likely to finance expensive purchases like real estate.

Involving the lender in the claim process can also make the payout or repair steps easier. The mortgagee oversees and coordinates the use of insurance funds. While homeowners may be new to the insurance process, lenders have the experience to keep repairs on track and prevent paperwork delays.

Do it by the book with Better

Mortgagee clauses give lenders peace of mind that their investment is recoverable, helping more home owners secure a favorable loan and buy their dream home. While policy documents and provisions seem daunting, you can count on Better to guide you every step of the way. 

At Better, we combine years of experience with the latest AI technology for a mortgage process that runs as smoothly as possible. Apply for pre-approval in as little as three minutes, lock in a competitive rate, and start searching for a house. Browse your options confidently, knowing that Better provides 24/7 support at every stage, from obtaining insurance to closing.

Make home buying a breeze with Better.

...in as little as 3 minutes – no credit impact

FAQ

Why is a mortgagee clause required by lenders?

Mortgagee clauses are part of nearly every mortgage agreement because they legally guarantee lender protection if a property undergoes substantial damage. The lender gets an insurance payout that covers the outstanding mortgage balance or, in the case of a partial loss, the cost of conducting repairs. This allows the mortgagee to supply loan funds with less financial risk.

Do you have to agree to a mortgagee clause to get a mortgage?

Yes, if your lender requests a mortgagee clause, you must agree to secure a loan, whether it’s a first mortgage, subordinate mortgage, or refinance. Lenders require this provision because, without it, if something damages or destroys the home, they would lose value on their investment or have to eat the cost of the outstanding mortgage balance.

Who provides the mortgagee clause?

The insurance company provides the mortgagee clause and includes it in the policy. Once it’s drafted and all parties approve it, it appears on the policy’s declarations page along with the lender’s information.

Can a mortgagee be a person?

Yes. If an individual lends you money instead of a financial institution, they become your mortgagee. This arrangement is called a private mortgage.