What Happens to the Mortgage When Your House Burns Down?

What happens to your mortgage if your house is destroyed in a fire

Even if your home is a total loss after a fire, you must continue to make your mortgage payments. Missed payments will affect your credit score and can trigger foreclosure. You should contact your mortgage lender right away to explore payment options as you rebuild.

Some lenders will honor a request for forbearance if you need to delay your mortgage payments for some time.

How to handle mortgage and insurance after a fire

While it may be overwhelming, taking these initial steps in the first few days after the fire can help you down the line.

1. Get in touch with local relief services: Organizations like the Red Cross or United Way can provide emergency food or temporary shelter. Dial 211 for information about local services, or search on Google “fire relief services” and your state to find local aid.
2. Contact your homeowner’s insurance company: Once you’re safe, contact your home insurance company and let them know you’ve had a fire. Your home insurance will work to start your claim and may have recommendations for companies that can start the clean-up process.
3. Request an advance from your insurance company: Your insurance company may be able to give you an advance on what you’ll eventually claim. You can use these funds for a hotel and some replacement items, such as clothing, while you figure out the details. Save every receipt to prove your costs.
4. Contact your mortgage lender: You’ll likely be working with your lender to repair the home, so make sure you inform them immediately.
5. Document all your damaged belongings: Take pictures of everything as proof of damage, and list all your personal items that need replacement. Include details like purchase date and cost. Don’t discard anything until after your insurance adjuster reviews it.
6. Secure the property: It’s your responsibility to ensure no further damage occurs, so board up exposed doors and windows and cover the roof if it is damaged. Look for a fire damage restoration company if the job is too big for you.
7. Get a copy of the fire report: Contact your fire department for a copy of the fire report for insurance and other official purposes. The investigation and report may take a few weeks or even months to complete, but your local fire department can advise you on time frames.

How insurance payouts affect your mortgage after a house fire

Your mortgage likely has a “loss payee” clause that states the insurance company must send claim payouts to the mortgage lender, rather than the homeowner. If you receive a check, your insurance company will write it out to both you and your lender. You’ll need to endorse it and send it to your lender. The mortgage company will hold these funds in escrow for your use to rebuild the property.

Your lender will issue payments at intervals during the rebuilding process. Work with them and the contractor to arrange for payments. It’s common for the lender to release 1/3 of the payment up front, 1/3 at the halfway point and the final 1/3 upon completion. Typically, the lender will require inspections throughout your rebuild to verify completed work.

If the cost of repairs is more than the insurance payout, you’re required to pay the difference. If you believe the payout is too low, you can dispute the amount. You may need to hire a public adjuster to help you determine a fair valuation. You can also file a complaint with the state or hire an attorney to help you challenge the insurance company.

Repairs are not typically less than the insurance payout. Michelle Youshock, head of personal lines for World Insurance Associates, explained: “For replacement-cost policies, insurers pay the actual cost to repair or rebuild — no more, no less. This is indemnity. Homeowners cannot ‘profit’ from a claim; payments must reflect the true cost of restoring the property to its pre-loss condition.”

Mortgage options if your house burns down: Rebuild, sell or walk away?

If your house burns down, whether from a wildfire or other cause, you ultimately have three options: You can rebuild, sell the home as is or walk away.

While it’s time-consuming, rebuilding and selling have the least or no impact on your credit. Walking away from the loss may be a quicker solution, but it’ll have a long-term negative impact on your future finances.

Rebuild

Rebuilding your home will likely give you the best outcome. Work with your mortgage company to repair your home, and then you can choose if you want to continue to live there or sell the newly repaired home.

If the insurance payout isn’t enough to cover the existing mortgage, this is probably your only option, other than just walking away and letting the home foreclose.

Youshock said, “Rebuilding is the most common. The upside is you restore your home and preserve long-term value. The downside is the time, stress, and potential cost overruns. It’s a process that requires patience and good project management.”

Sell

If the insurance payout is larger than the balance of your mortgage, you may be able to just pay off the mortgage and sell the land with the damaged property on it. Once the mortgage is paid off, the lender has no more claim to the property and can’t force you to rebuild.

For example, let’s say you owed $80,000 on your home and it was totally destroyed in a fire. If the insurance payout was $150,000, you could give $80,000 to the lender and pocket $70,000. You could then sell the land with the house on it in as-is condition. If you sold the land for $50,000, you’d walk away with a total of $120,000.

Before choosing this option, you’d want to do the math and see which works out to your best interest. If, in the above example, you used the $150,000 to repair the house and then could sell it for $300,000, you’d be better off making the repairs. In this case, you would sell the home for $300,000, pay off your mortgage of $80,000 and walk away with $220,000.

Youshock added additional factors to consider: a potentially lower sale price and the complications of the insurance payout going through the lender first in some cases. She continued, “Using the insurance money to pay off the mortgage can make sense … But you’ll still need somewhere to live, and without additional coverage, you may not have funds left to rebuild.”

Walk away

You might be tempted just to walk away from the whole ordeal and let your lender figure it out. However, according to Youshock, walking away should be the last resort.  You’ll still owe the balance of your mortgage, even if your house burns down. The mortgage company will foreclose on your mortgage, which will negatively impact your credit.

Youshock commented, “It ends the immediate burden, but it can be financially damaging long-term.” She included potential deficiency balances and difficulty securing future loans as additional consequences of walking away.

Credit and legal risks of a house fire on your mortgage

The house fire in and of itself will not have credit or legal risks. However, if you stop making your mortgage payment, your credit will be negatively affected. Your mortgage company will report late or missed payments, and eventually you’ll face foreclosure if you don’t make your payments.

If your loan is backed by Fannie Mae or Freddie Mac, you may qualify for forbearance of up to one year. If you have a conventional mortgage, it will be up to the lender to determine if you qualify.

You’re also legally responsible for preventing additional damage to the home. Secure your property from vandals, animals and the elements. Fire damage restoration companies can secure the home if you are unable to do so yourself. You should also check on the property regularly to make sure further damage isn’t occurring.

» LEARN MORE: How many house fires happen each year?