Good morning everyone! Today, I wanted to dive deep into a topic that often sends shivers down the spines of many investors: Insurance on Owner-Financed Deals. If you’re dealing with subject-to and wraparound mortgages, this is crucial information you can’t afford to miss.
The Importance of Insurance
Insurance is critical. It’s not just another expense; it’s your safeguard against potential financial disasters. Dealing with insurance can feel like a hassle, but skimping on it isn’t an option. This becomes even more complex when you’re working on owner-financed deals. If you ignore the nuances, you risk triggering the infamous due-on-sale clause and losing your investment. So, let’s break it down.
Risks of Not Having Proper Insurance
- Triggering the Due-on-Sale Clause:
- If the insurance isn’t in order, lenders may demand the full loan balance immediately.
- Financial Loss:
- Inadequate insurance could leave you scrambling for cash in the event of a fire, flood, or another disaster.
Key Terminology
- Seller: Original homeowner.
- Buyer: End buyer from the investor.
- Escrow Account: Account used by lenders to collect insurance and tax payments.
- Subject-To: Acquiring a property while keeping the existing financing in place.
- Wraparound Mortgage: A type of owner financing that “wraps” the new buyer’s loan around the existing one.
- Due-on-Sale Clause: A clause that allows lenders to demand full repayment if the property ownership changes.
Insurance Requirements for Subject-To Deals
When you buy a house subject-to, there are specific things you must do to keep the existing insurance and mortgage intact.
Seller’s Name on the Policy
Always ensure the seller’s name remains on the insurance policy. This is non-negotiable. It helps prevent the lender from realizing there’s been a transfer and invoking the due-on-sale clause.
Why Keep Seller on Policy?
- Escrow Account:
- Most mortgages collect taxes and insurance through escrow. Keeping the seller on the policy simplifies this.
- Avoiding Due-on-Sale Trigger:
- If the lender sees a policy change without the seller’s name, they might get suspicious.
Insurance Policy Components
Here are the elements your policy should include:
- Named Insured:
- The buyer should be the named insured.
- Also/Additional Insured:
- The seller needs to be listed as an additional insured.
- Primary Mortgagee:
- The seller’s bank should be the primary mortgagee.
- Secondary Mortgagee:
- Your investment company should be the secondary mortgagee.
- Minimum Coverage:
- Ensure the policy covers at least the loan amount to the buyer.
Types of Insurance Policies
Actual Cash Value (ACV) Policy
An ACV policy takes depreciation into account. For example, if a roof is expected to last 10 years and it’s destroyed in year 5, you’ll only get half its value.
Replacement Cost Value (RCV) Policy
An RCV policy pays out the full cost to replace damaged items, regardless of depreciation. These policies are more expensive but offer better coverage.
Preference for RCV Policy
Always aim for an RCV policy. While pricier, it ensures you’re fully covered for replacements, avoiding unexpected out-of-pocket costs.
Finding the Right Insurance Agent
Knowledge is Key
Your agent must understand subject-to and wraparound mortgages. If they have to Google what you’re talking about, move on.
Vetting Agents
Ask if they’ve handled subject-to or wrap transactions before. If they hesitate, find someone else.
Recommended Agent
We use Victor Miranda for many of our deals. He’s knowledgeable and reliable, though not perfect. Always communicate that your referral comes through trusted sources to get the best service.
Insurance for Rentals vs. Wraps
Rental Requirements
If you’re buying subject-to and renting out the property, you’ll follow similar steps. The named insured will be your investment company while keeping the seller and their bank on the policy.
Wrap Requirements
For wraps, the process is more complex. You need to ensure your buyer is the named insured and meet all other requirements previously discussed.
Power of Attorney (POA)
Importance of POA
Always secure a power of attorney (POA) from the seller when closing a subject-to deal. This allows you to handle future transactions without needing the seller’s involvement.
Limiting POA
Limit the POA to transactions specifically related to the property. This provides comfort to the seller while granting you necessary control.
Insurance Claims Process
When claims occur, checks will often require multiple signatures. Ensure you have the POA to keep the process smooth.
Multiple Signatures on Claim Checks
Claim checks from insurance will usually have everyone’s name on them – the buyer, seller, lender, and your investment company.
Using POA for Uncooperative Sellers
If the seller becomes unreachable or uncooperative, the POA lets you sign on their behalf, ensuring you can handle claims efficiently.
Other Insurance Considerations
- Private Lenders: If you have private capital, ensure their interests are covered in your policy.
- Consulting Professionals: Always consult attorneys and insurance agents familiar with these transactions.
- Written Policies: Have a written policy outlining your insurance requirements to avoid allegations of discrimination or unfair practices.
Key Takeaways
Navigating the complexities of insurance in owner-financed deals, particularly with subject-to and wraparound mortgages, is essential for protecting your investments. Ensuring the proper insurance coverage not only safeguards against potential financial disasters but also prevents triggering the due-on-sale clause, which could jeopardize the entire deal. By understanding the key terminology, insurance requirements, and the importance of securing a power of attorney, investors can mitigate risks and streamline the claims process. Always work with knowledgeable insurance agents and consult with professionals to ensure all aspects of the transaction are covered. With the right precautions and policies in place, you can confidently manage and grow your investment portfolio.
