First, a little legal vocabulary lesson. Before moving forward, there are two main terms you need to understand: mortgagee and mortgagor. The mortgagee is the lender that provides funds to someone buying property. The mortgagor is the person borrowing those funds (in this case, you).

A mortgagee clause is a specific section in your homeowners insurance policy that makes the lender a payee for the insurance payout—up to the amount you still owe on your mortgage—in the event that the property is majorly damaged or completely destroyed.  

Important to note: The mortgagee clause does not necessarily apply for every small claim. Little Timmy tossing a baseball through your window will probably stay between you and your insurer. Tornado damage that makes your home unlivable, however, will likely trigger the clause. Check your homeowners insurance policy for specifics.

How does a mortgagee clause protect lenders? 

As a mortgagor, you offer the title of your property as collateral when you take out a home loan. If you can’t make the payments and end up defaulting on your loan, the mortgagee has the right to foreclose on your home and sell it to make up any money you haven’t paid back. However, if the property is heavily damaged or destroyed and can’t be sold, foreclosure alone may not cover the lender’s loss. In that situation, the mortgagee clause helps protect the lender by ensuring insurance proceeds account for the remaining loan balance.   The mortgagee clause also protects the lender from the decrease to the property’s value that could happen if you were to pocket an insurance payout without actually repairing the property or if you damaged the property on purpose.  

Does the mortgagee clause protect homeowners?

Rest assured, the mortgagee clause is in your best interest, too.  Even if your home is damaged so badly that it's unlivable, you’re still responsible for the remaining balance of your home loan. A mortgagee clause coordinates the insurance payout to help protect you from paying for a home you can’t live in or sell.  

The layer of security the clause offers also makes lending less risky for banks and other financial institutions, so borrowers like you can get a big enough loan to afford the perfect home.

If you have homeowners insurance with a mortgagee clause, both you and your lender are financially protected if your home is destroyed by a covered claim such as:  

• Fire and smoke
• Wind and hail 
• Lightning strikes
• Theft or vandalism
• Personal liability if someone is injured on your property  

Let’s hope none of this happens, but if it does, your insurance company will assess the damage, determine the payouts and settle up with you and your lender.  

In situations where it’s possible to fix the damage, your insurance company will likely send you a check to pay for the repairs. Usually, the check will list both you and the lender. If the insurance company issues the check directly to your lender, you’ll need to follow your lender’s instructions to access the funds and coordinate repairs.  

If the damage is irreparable, your lender will be first in line for the insurance payout. The insurance company would compensate your lender up to your remaining loan balance. Then, you’d receive a payout up to the amount of equity you have in the home and your mortgage debt would be wiped clean.  

Mortgagee clause example  

Let’s pretend you buy a home for $500,000 with a $100,000 down payment, which makes your mortgage $400,000. You buy a $500,000 homeowners insurance policy to cover the total value of the home with a mortgagee clause in place.  

Let’s say the home is destroyed by a fire right after you bought it. In this scenario, the insurance company would give your lender $400,000 to cover your remaining mortgage debt and pay you $100,000 to replace the home equity you lost.

Most lenders will require you to get a homeowners insurance policy with a mortgagee clause baked in.

Getting a mortgagee clause is pretty smooth sailing. Before you can close on a home, most lenders ask you to secure a homeowners insurance policy that includes a mortgagee clause. When setting up your policy, you’ll need to ask the insurance company to add a mortgagee clause to it. Be prepared to give the insurance company your lender’s details and loan number.

Here are some new terms you might stumble across in a mortgagee clause.  

 Lender protections  

 Lender protections are what the mortgagee clause is all about: the part that shields the lender from financial loss if the property is damaged or destroyed. These protections ensure the lender will recoup their losses from the insurance company, even if you deliberately damage the property.  

Loss payee  

Here’s an easy one—loss payee is just another word for the mortgagee (in this case, the lender) that stands to receive the insurance company’s reimbursement. You might also hear mortgagee clauses referred to as “loss payee clauses.”  

 Its successors and/or assigns (ISAOA)  

 ISAOA stands for “its successors and/or assigns.” This phrase enables your lender to hand over their rights to another bank or financial institution. It comes into play if your lender decides to sell your loan on the secondary mortgage market. Not to worry, this is a common practice that helps lenders free up money to issue more loans and usually would not effect you as the the borrower.

 As their interests may appear (ATIMA)  

The sidekick to ISAOA is ATIMA, meaning “as their interests may appear.” This phrase lets the lender extend the insurance policy to third-party groups they do business with, even if they aren’t specifically named in the contract. So, if your lender sells the loan to a third party, they’ll also be shielded from financial loss.