There was a fire last May. The entire house was destroyed by fire. The Insurance Company paid to have the remainder leveled and the debris removed.
That was 9 months ago. Now, what?
Actually, nothing! That’s a sad commentary, but it may indeed be quite factual.
Who got the insurance money? Nobody, it was never paid out, or all the money went to the mortgagee.
So, let’s assume that there is a house sitting on a property in a subdivision. It’s worth $1,500,000.00. There’s an $800,000.00 mortgage on the property. The mortgage was taken out 2 years ago at an annual interest rate of 2% per annum.
The house itself is worth $700,000.00, however it was only worth $500,000.00 when the property was initially purchased.
Insurance Policy
The insurance policy was issued when the house was worth $500,000.00. This means that the insurance payout will be $200,000.00 short.
However, the policy actually contains a co-insurance clause. That means that the homeowner was to update the policy each year to keep place with the new values. The current value is $700,000.00 and the actual limit on the policy is $500,000.00. This means that the homeowner only has 5/7ths of the amount of insurance required. The homeowner has become a co-insurer for 2/7ths of the loss.
The insurer will payout 5/7ths of the amount of the policy. That’s 5/7ths of $500,000.00 or $357,143.00. And, all the while, the homeowner probably thought that they had $500,000.00 of insurance.
The good news is that most insurers do not have a co-insurance clause anymore. It used to be quite common, however, it still exists in some policies.
The new policies often include a “replacement cost” endorsement. This means that the homeowner originally purchased a $500,000.00 policy, which went up each year and it’s now going to payout $700,000.00 which is the amount of the actual loss.
The Mortgage
Not every homeowner holds title free and clear. They have a mortgage and in this case, the mortgage is $800,000.00. So, who gets the $700,000.00 in insurance money?
Well, that all depends.
The Mortgages Act
Here’s the applicable provision in the Mortgages Act:
“Application of insurance money
6 (1) All money payable to a mortgagor on an insurance of the mortgaged property, including effects, whether affixed to the freehold or not, being or forming part thereof, shall, if the mortgagee so requires, be applied by the mortgagor in making good the loss or damage in respect of which the money is received.
Idem
(2) Without prejudice to any obligation to the contrary imposed by law or by special contract, a mortgagee may require that all money received on an insurance of the mortgaged property be applied in or towards the discharge of the money due under the mortgagee’s mortgage.”
(italics mine)
Who is the mortgagee and what did it say in the Standard Charge Terms that were registered against the title to the property?
Standard Charge Terms
These are the ones drafted by Dye & Durham and available for anyone to use.
“Obligations to Insure
16. The Chargor will immediately insure, unless already insured, and during the continuance of the Charge keep insured against loss or damage by fire, in such proportions upon each building as may be required by the Chargee, the buildings on the land to the amount of not less than their full insurable value on a replacement cost basis in dollars of lawful money of Canada.
Such insurance shall be placed with a company approved by the Chargee. Buildings shall include all buildings whether now or hereafter erected on the land, and such insurance shall include not only insurance against loss or damage by fire but also insurance against loss or damage by explosion, tempest, tornado, cyclone, lightning and all other extended perils customarily provided in insurance policies including “all risks” insurance.
The covenant to insure shall also include where appropriate or if required by the Chargee, boiler, plate glass, rental and public liability insurance in amounts and on terms satisfactory to the Chargee.
Evidence of continuation of all such insurance having been effected shall be produced to the Chargee at least fifteen (15) days before the expiration thereof; otherwise the Chargee may provide therefor and charge the premium paid and interest thereon at the rate provided for in the Charge to the Chargor and the same shall be payable forthwith and shall also be a charge upon the land.
It is further agreed that the Chargee may at any time require any insurance of the buildings to be cancelled and new insurance effected in a company to be named by the Chargee and also of his own accord may effect or maintain any insurance herein provided for, and any amount paid by the Chargee therefor shall be payable forthwith by the Chargor with interest at the rate provided for in the Charge and shall also be a charge upon the land.
Policies of insurance herein required shall provide that loss, if any, shall be payable to the Chargee as his interest may appear, subject to the standard form of mortgage clause approved by the Insurance Bureau of Canada which shall be attached to the policy of insurance.”
You will notice that there was no requirement for the insurance moneys to be paid to the mortgagee.
TD Canada Trust Standard Charge Terms
By way of example, let’s have a look at the Standard Charge Terms of one of the big Banks, in this case TD Canada Trust. Referencing “525286 last revised November 2018, filing 201814”. The document states:
“ 3.08 Insurance
(j) The Bank in its discretion may require that all insurance proceeds be paid to the Bank,….”.
Similarly, other Banks when drafting up their own wording for their mortgages contain almost identical provisions.
The Result
If it was an ordinary mortgage, payable to a friend, colleague or relative, then, the insurance moneys whatever they happened to be went to the homeowner.
If there was an institutional mortgage with an “A or B lender”, then, the funds may have gone to the mortgagee to pay off the mortgage.
The Implications
In our example, the homeowner took out the mortgage 2 years ago at the then current rates of 2% per annum for a five year term, 2021 running to 2026.
Now, the Bank wants its money back. The homeowner no longer has a house on the property qualifying for even current 5% rates, the homeowner will require a construction loan at 8 and ½ %. This new mortgage would run for 12 months while the building is under construction. Once completed, the homeowner would qualify for a regular residential mortgage at the then current rates to replace the construction loan.
This means that our homeowner who thought they had a 2% mortgage, now finds that they need an 8 and ½% mortgage, for the next year, and they also need to pay rent somewhere while they wait for their house to be rebuilt.
This means that the homeowner may take some considerable time to rebuild or may decide to sell the property in its present condition.
Brian Madigan LL.B., Broker