Mortgage Errors and Omissions Insurance

Mortgage errors and omissions insurance protects the bank from errors made in the management of the collateral or government guarantees that support a mortgage.

There are several different versions of the policy. Some are stand-alone, as in a separate policy. Some are included in the bank’s insurance package policy (along with the bank’s building insurance and general liability insurance).

Mortgage Impairment

This section protects your interest in a mortgage from a physical damage loss (e.g., fire, lightning, wind, etc.) as a result of “required” perils when your customer has not kept insurance in force or has not properly insured the property.

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Mortgage Impairment Example

A mortgage customer allows his or her homeowner’s insurance to lapse. Your loan department is not aware of the cancellation. The home is in a fire, leveling the structure. The loan goes into default. Mortgage impairment insurance protects the bank against loss of the outstanding loan amount.
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Most policies respond to the perils (causes of loss) required in the mortgage agreement. If the loan requires “fire, extended coverage, and vandalism,” then the mortgage impairment policy responds only to those perils. The insurance responds to the coverage required by your mortgage.

Some mortgage impairment policies require that the bank tracks and checks customer insurance policies. Some require regular notice to customers of the mortgage requirement to purchase insurance. Some don’t require any form of tracking customer insurance policies, saving the bank a great deal of effort and administrative expense.

Most policies limit coverage for a set time from the date you are aware of a lapse in the insurance — usually ninety days. This allows you time to place coverage in your “forced-placed” property insurance program. (See chapters ten and eleven for forced-placed coverage.)

Non-Required Perils or Balance of Perils

This additional coverage supplements the perils covered by the first part of the mortgage impairment policy. Don’t overlook the importance of this section. Your mortgage’s required perils may not include damage by weight of ice and snow, vandalism, frozen pipes, water damage, or building collapse. Coverage can also be included here for flood and earthquake.

Mortgagee’s Errors and Omissions

Coverage for errors in the administration of escrowed insurance premiums or in the various government guarantee programs —VHA, GNMA, SBA, etc. The policy may include mistakes in determining the flood map location of the property. Failure to administer property tax payments properly for the customer is also a part of many policies.

General Comments

There is no universal mortgage errors and omissions policy language. Each insurer’s policy is unique, with distinctive terms and conditions. You need to read and understand your policy.

Be sure the perils included in your coverage are broad in nature. Consider adding flood and earthquake to the policy.

Some insurers exclude mobile homes from coverage on the basic policy. You can purchase the coverage for an additional premium.

Most mortgage errors and omissions policies require that you obtain proof that insurance is in place at the time the mortgage is closed. You can do nothing that would lead a mortgage customer to believe he or she doesn’t need to buy insurance.

Some mortgage impairment policies require that you annually provide a written notice to customers that insurance is required as a condition of the mortgage.

Review your policy to see if you are required to maintain proof of insurance coverage. Most policies now only require action at the time you are notified that coverage has been cancelled. So-called “non-checking” policies allow your loan department to ignore renewal notices and precancellation notices. You can even ignore the cancellation notices for several weeks, enough time for late-paying customers to have their policies reinstated.

Non-checking policies allow your loan department to hold off on any action for as long as ninety days from the date you know that a policy has been cancelled. Many banks use a sixty-day schedule; they follow up on policies that have not been reinstated sixty days from cancellation. That gives them plenty of time to put coverage into place on the “forced-placed” insurance program if need be.

Mortgage-Impairment vs. Mortgage-Hazard Insurance

There is a fair amount of confusion by bankers over the two types of insurance coverage that protect the bank against customers who fail to buy insurance on their mortgaged properties — mortgage-impairment insurance and mortgage-hazard insurance.

The coverage is different. The triggers of payment under the policies are different. The premiums are different.

Mortgage-impairment covers the mortgage.

Mortgage-hazard covers the mortgaged property.

Note the difference.

Mortgage-impairment covers the mortgage to the extent that the mortgage becomes “impaired” due to direct physical loss or another covered incident. Said another way, the loss is a default of the mortgage due to a covered incident that damages the mortgaged property.

Mortgage-hazard is direct property insurance coverage for a building; the insurance loss is triggered by damage to the building. The policy does not care if there is a mortgage default. A loss to the building prompts a payment following the terms of the insurance policy.

Mortgage-hazard is broader coverage and provides more flexibility to the bank. It is better than mortgage-impairment insurance in most cases. It is also more expensive.

Mortgage-Hazard Insurance

Mortgage-hazard insurance responds to a property loss that takes place at the mortgaged property when that loss is not covered by insurance. Unlike mortgage-impairment insurance, foreclosure does not have to take place for the mortgage-hazard insurance to pay.

The bank may pay for the repair of the property and add the repair costs to the current loan. They may foreclose, but they don’t have to.

Again, foreclosure is not precedent to coverage under the mortgage-hazard policy. The policy responds to an otherwise uninsured physical damage loss (e.g., fire, wind, hail, etc.) to the covered property. It is the bank’s option as to when to use this coverage as first-party coverage. Damages or premiums do not have to be billed back to the borrower.

Mortgage-Hazard Example: A customer of the bank fails to renew his or her insurance. A fire damages the property. The customer cannot pay to repair the damage.

The bank submits the claim to the insurer based on the damage done to the property. The bank may have the property repaired and add the damage amount to the current mortgage, allowing the mortgage customer to stay in his or her home. The bank may “forgive” the loss amount, or it may go to foreclosure and take over the property.

The disposition of the mortgage is up to the bank. The bank’s loss in value due to the loss to the property is paid by the mortgage-hazard policy. The policy allows for flexibility in action by the bank.

 

Mortgage-

Impairment

Mortgage-

Hazard

Protects the bank’s interest in mortgaged property when the mortgage customer fails to buy insurance.

Yes

Yes

Responds to damage to mortgaged property.

After foreclosure precipitated by property damage.

Yes

Requires liquidation.

Yes

No

Requires that the bank track insurance.

At bank’s option as declared in policy.

No

Requires that the bank force-place coverage if a property is found to be without insurance.

Yes

No

Policy responds to perils required by mortgage.

Yes

Yes