ome Face Paper Chase Getting Quake Checks : Insurance: Homeowners may find that their checks for repairs are also made out to their mortgage lender.

Thousands of local homeowners are starting to receive eagerly awaited checks from their insurance companies for repair and reconstruction of properties damaged in the Northridge earthquake.

Many of you may be surprised, however, to find that these checks are made out to you and your mortgage lender. Without consent of such a mortgage holder, the checks can’t be cashed and the money can’t be spent on repairs.

Lenders and other lien holders are named on insurance company checks for two reasons. While residential lenders don’t generally require borrowers to get earthquake insurance, earthquake coverage is usually just a rider or endorsement to general casualty policies in which lenders demand that they be named as payees. Also, insurance companies want to avoid lawsuits by lenders that might claim an insurer ignored the lender’s interest in the property.

Unfortunately, insurance companies and lenders don’t follow any across-the-board policy in handling earthquake checks, which only adds to the paper chase nightmare that many homeowners with quake damage are already going through. Some insurance companies include the policyholder and all lien holders on all their earthquake damage checks. Other companies include lien holders only if the check is for more than a certain amount of money arbitrarily set by the insurance company.

Lenders have differing policies too. Depending on the size of the check, a lender may simply endorse the check and hand it back to the borrower, or the lender may place the check proceeds into an escrow account and release the funds only after the borrower offers proof that quake repairs have been made. The lender, however, can’t generally keep the money.

“Lenders are supposed to be named in all checks regardless of the amount, but this isn’t done,” said Marlyn Dinon of Western Insurance Information Service, a nonprofit trade group funded by insurance companies in the 10 Western states. “Where the damage is small, the lien holder is hardly ever named.”

20th Century Insurance Co. in Woodland Hills, however, is naming all known lien holders on its earthquake checks, said Rick Dinon, vice president at 20th Century and the husband of Marlyn Dinon. Lenders holding a second mortgage on the property will not appear on the check if their mortgage contract didn’t require that they be named as a loss payee, he said. Otherwise, “a loss payee endorsement to the insurance policy ensures that the lender will be on the check.”

Cashing an earthquake insurance check may be further complicated for borrowers who have refinanced, or who have had their loan sold in the so-called secondary market, Dinon said. If the name of the old mortgage holder is on the check, the policyholder has to send the check back to the insurer, along with information about the new mortgagee. Homeowners who haven’t received a check in the mail yet should call their insurer and find out in advance about any joint payees, Dinon said.

Alas, there is a lot of confusion about earthquake damage checks. For instance, a friend of mine in Woodland Hills who has earthquake insurance with 20th Century was told that he would get a $1,000 check for his earthquake damage. A 20th Century claims employee also told him that because his check was for less than $1,500, it would be made out directly to him and would not include his mortgage company. The 20th Century person said the $1,500 cutoff was required by state law. In fact, there is no such law, according to the California Department of Insurance. And my friend did get his $1,000 check made out directly to him.

Safeco Corp., an insurance company based in Seattle, has a more lenient policy regarding insurance checks than 20th Century. Earthquake damage checks issued for less than $5,000 by Safeco will generally not include any mortgage companies, said Robie Baker, catastrophe manager for the insurer in Glendale. But putting lenders’ names on larger checks “keeps people from walking away from their homes,” he said.

“Most mortgagees will bend over backward to work with catastrophe victims,” Baker said. “But we can’t force them to hold by any standard.” Unfortunately, he said, some mortgage companies “will sometimes put our policyholders in a Catch-22 because they won’t release insurance proceeds to a homeowner until the work is done. I try to referee these situations and get the parties to work the situation out.”

At California Federal Bank, any earthquake checks from insurance companies for less than $10,000 can be endorsed over to the homeowner on the spot by a branch manager, said Donald L. Black, senior vice president, while checks of more than $10,000 are “handled on a case-by-case basis.”

*

In deciding whether to endorse a larger check or place the funds in escrow, Black said, the savings and loan looks at the borrower’s past relationship with the institution, the value of the property and the size of the loan.

Cal Fed won’t use its power to withhold funds as a way to force certain troubled borrowers to pay up on their loans. “We would not require that a borrower bring the loan payments current before endorsing a check,” Black said. “We’ve chosen not to do that.”

At Lomas Mortgage USA in Dallas, most insurance company earthquake checks for $10,000 or less are being endorsed and sent back to borrowers to spend at their discretion. But checks of more than $10,000, or checks being forwarded to Lomas by a borrower who is behind in payments, will be placed into a separate interest-bearing account, with the money released in stages, said Kelly Eckels, a Lomas assistant vice president.

Some real estate loan documents state that the lender can demand that any insurance proceeds be used to reduce a borrower’s debt, rather than repair the property. Despite what the documents say, courts generally won’t allow such a provision to be enforced, said John H. Kuhl, partner in charge of the real estate finance practice at the Century City law firm Cox, Castle & Nicholson. According to the 1978 California appellate court case of Schoolcraft vs. Ross, a borrower is entitled to use insurance proceeds to rebuild premises that have been damaged. A lender has to show that its security is being “impaired” before insurance proceeds can be used to reduce the debt.

A lender may be able to argue that its security is being impaired, however, if the property cannot be restored to its condition and value just prior to the casualty, Kuhl said. “Only an extremely aggressive lender would try to deny a borrower the money to rebuild,” he added. “And a court would most probably decide in favor of the homeowner.”

The net effect of Schoolcraft and provisions in California’s Civil Code is that mortgage lenders may have the right to receive and control earthquake damage proceeds. But lenders are still required to make those proceeds available to pay the cost of repairing the damage that caused the money be available, Kuhl said. “Surprisingly, we are not hearing about too many disputes between borrowers and lenders. It seems that most borrowers and lenders are able to agree without resorting to the lawyers.”