How to structure coverage so all parties are protected
Insurance is one of the most important parts of a creative finance deal. When done correctly, it protects the seller's equity, the buyer's investment, and the lender's interest.
A properly structured insurance policy for a creative finance deal should include:
The seller's name remains on the policy. This is essential. Do not remove them.
If the property is held in a revocable living trust or revocable trust, the trust should be named as an insured.
The buyer or their entity is added as an additional named insured to protect their interest.
The original lender remains listed as the loss payee. This protects their collateral interest and avoids triggering reviews.
When a property has multiple named insured parties and a mortgagee, insurance claims are often handled in this order:
The insurance company issues a claim check. For many claims, the check will be made payable to the named insured(s) and the mortgagee (lender).
Because the check can be made out to multiple parties, they must endorse it before it can be used. This helps protect the interests of those involved.
In many cases, the lender will release the funds to be used for repairs. Insurance claims and payouts depend on the policy, the loss, and the lender’s process.
When property is held in a trust, the trustee often oversees how repair funds are used to ensure the work is completed.
Key point: The insurance claims process in creative finance is essentially the same as any situation where there's a mortgage on a property. The lender protects their interest, and funds are used to repair or restore the property.
If a property is completely destroyed (total loss), the insurance payout follows a specific priority:
The bank holding the first mortgage is paid first from the insurance proceeds. This is exactly how it works in any traditional mortgage situation. The mortgage balance is cleared.
If the seller carried a second-position note for their equity, they are paid next from the remaining proceeds. The seller's equity is protected because the property was insured at replacement value.
Any remaining insurance proceeds after the mortgage and seller note are satisfied go to the buyer as the beneficial owner of the property.
No. Adding additional named insured parties to a policy is a normal occurrence and does not require lender notification. The key is that:
Insurance companies handle this routinely. There's no reason to contact the lender.
The buyer typically pays for insurance as part of their monthly obligation. This is usually handled through a loan servicer who collects insurance and tax escrow along with the monthly payment, then pays these bills on behalf of all parties.
Yes, but the new policy must maintain the same structure:
It's often advisable to keep the existing insurance company to avoid any gaps or changes that might draw attention.
The property should have:
If the property will be rented, it may need a landlord policy rather than a standard homeowner's policy. Discuss specific requirements with an insurance agent who understands investment properties.
When property is held in a trust and an insurance claim is filed:
The trustee acts as a neutral party helping ensure everyone's interests are considered during the claims process.
Q: Who should be named on the insurance policy in a creative finance deal?
A: The seller (original borrower), the trust (if applicable), the buyer or buyer's LLC, and the existing lender in the mortgagee clause.
Q: In a total loss, who gets paid first from the insurance proceeds?
A: The existing mortgage (first position) is paid first, then the seller's equity note (if in second position), then any remaining goes to the buyer.
Q: Why does the seller remain as a named insured?
A: The mortgage is still in their name, so they need to be protected. Removing them could create issues with the lender.