Fire and hazard insurance is an often overlooked but indispensable part of every note transaction that includes buildings. Note buyers often ignore it when only vacant land is involved, but they expose themselves to serious losses without proper insurance on any structures.
It’s a matter of keeping the security secure. If the structures are completely destroyed, the policy must be enough to cover the balance due on your note. That means you must be certain of four key things:
- The property securing the note is insured.
- The coverage is adequate.
- The carrier has enough assets to pay claims.
- You are named on the policy as the mortgagee.
Despite how badly the note buyer needs this insurance, confirming it is one of the hardest tasks in putting the transaction together.
How to find the insurance carrier
Your first hurdle is finding out who the insurance carrier is. That may sound easy, but it can be exasperating. You may get the company’s name without any problem. If not, here are some tips.
In many cases the person you’d expect to know, the note seller, hasn’t a clue. That’s because the insured isn’t the note seller, it’s the payor. Note sellers often don’t realize they should be named on the policy as the mortgagee. Even if they are named, they may not know which company carries the insurance.
Then you’re faced with asking the payor. The payor almost always knows the answer, but as often as not has no intention of telling you. Payors have no incentive to cooperate: it costs them unpaid time and effort, and they may want to buy their own note from the seller at the same discount you offered, which makes you a competitor.
If the payor won’t tell you, you can sometimes persuade the settlement agent who originally closed the sale of the property. This escrow closer might have a record, although seller-financed sales are often closed without insurance being part of the escrow.
If the note you’re buying is a second lien, ask the first lienholder, who will most likely know the name of the insurance company.
There could be a hitch: escrow closers and senior lienholders may not want to give you this information without the payor’s consent, which puts you back where you started.
Get a copy of the policy
Once you have the carrier’s name, request a copy of the policy. Start by contacting the insurance representative.
Since this can be a little tricky, put your best foot forward. A friendly conversation with the agent might tell you a lot about the coverage, the property, the payor and the carrier. This talk could be a gold mine of information.
Fire and hazard policies tend to be thick documents, so the representative may not be willing to send the whole thing. Ask for a one-page synopsis. Even a synopsis will help.
Four questions to ask about the policy
Once you have the policy, examine it carefully to answer these questions.
1. What exactly is covered, and to what extent?
Does the policy match the note’s requirements? Read both the note and the deed of trust or mortgage carefully for language requiring the payor to provide and maintain insurance. Be sure this language exists, or the payor may not be obligated to carry insurance at all.
If the note is for land only, insurance may not be necessary. Usually only the buildings are covered, since they are what can be destroyed.
Check for special problems with the property’s location. Is there coverage for natural disasters such as earthquakes or floods?
Make sure you’re protected against intentional acts of the payor, such as arson. Many policies won’t cover you if the payor deliberately destroys the property. If you aren’t covered against intentional acts, your note carries more risk.
If the policy doesn’t provide enough coverage, or there is no policy, find out why. If the payor isn’t required to carry insurance, you may have to pay for it yourself, and you should factor that expense into the cash price you offer for the note.
2. What is the amount of coverage, and is it enough?
Don’t expect the insurance to cover any set dollar amount. Coverage could be much less than the value of the land and buildings, because land itself ordinarily isn’t insurable.
For example, say the policy is for only $50,000, and you’re paying $75,000 cash for a $90,000 note. The coverage may be enough, because only the structures are insured, not the land. Considering the land value plus the insured value of the buildings, you may feel satisfied that your note has enough coverage.
But it may not. For real safety, a policy large enough to cover the balance due on your note is the best protection if the structures are completely lost.
3. Is the carrier financially sound?
Check out the insurance company to make sure it has enough assets to settle claims. You can start by asking your state’s insurance commissioner about the carrier. You can also look up the independent companies that rate insurance carriers.
4. Who is named on the policy, and why?
Are both the payor and the seller named? The answer gives you a good clue about getting your own name on the policy as the new mortgagee.
Is someone other than the payor named? If so, why? If the seller isn’t on the policy, was that merely an oversight, or is there a problem with the payor or the carrier?
Getting named as mortgagee
Your next step is to have the seller’s name taken off the policy as mortgagee and yours put on instead. Usually a written request to the insurance representative, explaining your purchase of the note, is enough.
Some agents may be confused by the request. They may tell you the seller’s name isn’t even on the policy, so why should yours be? Be patient. Explain the history of the note and your pending purchase so the representative understands why you need to be named.
Other agents may be suspicious, and you may need to send documents proving the request is legitimate. Some companies believe they need the payor’s written permission before adding your name. With an agreeable payor, that’s no problem.
When the payor won’t cooperate
If the payor is unwilling to have you named as mortgagee, you still have options. If the seller is already named on the policy, the seller’s written instructions to substitute your name may be enough. If that doesn’t satisfy the carrier, try these:
- Send backup documents to the insurance representative and explain the situation personally.
- Build a friendly line of communication with the payor and persuade them to give written authorization for you to be named mortgagee.
- Buy your own policy on the property. This is sometimes called “force-placed insurance,” and it can be very expensive and hard to get. You can try to get the payor to reimburse the cost after closing.
- Foreclose if your name isn’t put on the policy. This is an extreme measure. It can work, but I don’t recommend it, because it exposes you to loss between closing and foreclosure. You can’t collect for losses if you’re not named as mortgagee, and you’d have to close the deal without being named.
Before and after you close
Insurance problems can kill a deal. If you can’t get your name on the policy, the coverage is inadequate, the carrier seems risky, or you aren’t covered for intentional acts by the payor, you have a risky note.
You certainly want to rethink the purchase if, for example, you can’t reach the payor to ask questions in the first place. They may be sick or out of town, but they could just as well be trying to sour your deal.
Now assume a better outcome: you have permission to be named as mortgagee. It can take time for the carrier to process the change. You not only have to order it, you also need written verification from the carrier that it’s done. I recommend having written proof that you’re named as mortgagee before you close.
Say you’ve closed, you own the note, and payments are coming in regularly. It’s not over yet. Insurance companies are supposed to notify mortgagees when a policy is canceled, but they often don’t. You could get a rude awakening if something happens to the property and you discover the policy was canceled months earlier.
Always set up a “tickler file” that prompts you to contact the insurance company at least once a year (every six months is better) to make sure the policy is in force. Don’t neglect this one.
One last point: have your attorney review your insurance coverage and documentation. It’s a further cost, but it’s a necessary safeguard. It could save you the purchase price of the note.
