Even as You Stare Down Documents at Settlement, Be Ready for Disaster at Home

Q: Last year my wife and I bought a new home. A couple of weeks later, the town where we live was heavily damaged by a tornado and strong straight-line winds. Our neighborhood was particularly hard hit, with at least two homes destroyed. Our house sustained damage as well, and we received a fair insurance settlement to make necessary repairs. We have a mortgage, and the insurance check was made out to us and to the mortgage company. We were informed that the lender would distribute the insurance proceeds only after it receives estimates from contractors and itemized lists of the cost of materials and labor.

Do I have any rights in this matter, or does the mortgage company have the legal right to hold the check and distribute it only as it deems necessary? It's a little difficult to get contractors to do repairs when they know they will have to wait on an inspector and then wait until the lender agrees to send money.

A: Read your mortgage document carefully. When you went to settlement, you signed two important legal documents: a promissory note and a deed of trust, also called a mortgage. The latter contains all of the rights and obligations that you, the borrower have.

For example, if you are late with your monthly payments, you are in default. Sections in the deed of trust spell out what your lender can do to you, including calling the entire loan due after proper notice or starting the foreclosure process.

At settlement, most consumers do not bother to read the deed of trust. It is lengthy -- usually 14 or 15 pages -- and legalistic. More importantly, because it is a standard form used by the lender, it is almost impossible to change the terms. The lender's position is usually, "If you want my loan, then sign my legal documents."

One section of the deed of trust is "Property Insurance." Here is a portion of that section:

"In the event of loss, Borrower shall give prompt notice to the insurance carrier and Lender. . . . Unless Lender and Borrower otherwise agree in writing, any insurance proceeds . . . shall be applied to restoration or repair of the Property, if the restoration or repair is economically feasible and Lender's security is not lessened. During such repair and restoration period, Lender shall have the right to hold such insurance proceeds until Lender has had an opportunity to inspect such Property. . . . Lender may disburse proceeds for the repairs and restoration in a single payment or in a series of progress payments as the work is completed."

Assuming that your deed of trust contains similar language, there is nothing you can do at this point. In fact, I have been involved in situations in which the lender flatly refused to pay any contractor and instead credited the entire insurance check against the outstanding balance of the loan.

I am surprised, however, that contractors are reluctant to go forward with your job. There are a lot of good, licensed contractors looking for work, and in your case, the money is literally "in the bank."

Your contractor should talk with the lender, so as to be satisfied that payment will be made. While it is true that payment may be on a schedule (i.e., you get a certain amount when the drywall is done, and another amount when you complete the electrical work), this is not unusual in home improvement contracts. Indeed, I always recommend that homeowners work out such a schedule.

You were fortunate that you had adequate coverage. Unfortunately, not everyone does. And even with coverage, you may not have properly prepared for the next disaster.

According to the National Association of Insurance Commissioners (www.naic.org), there are several steps you should take immediately: