The “Standard Mortgage Clause” and its Importance

While terms like “standard mortgage clause” may cause most people’s eyes to glaze over, understanding its significance is more interesting and important than you’d think.

If were to you take a look at the fine print in almost every lender’s mortgage commitment, you’d find a requirement that the borrower’s house insurance must include a “Standard Mortgage Clause”.

Now, we’d bet that 99% of the population has no idea what this is.  It’s kind of like the grease in our car’s wheels; we know we need it, but have no idea what it actually is and never think about it.

Fair enough.  But the reason for the standard mortgage clause is actually more interesting than it sounds.  Seriously.

Because essentially, it protects the lender if the property owner does something to void the insurance coverage. 

Here’s an example: say a house was insured as a principal residence.  Then the owner decided to rent it out.  That change of use could actually void the insurance and let the insurer off the hook if there was a claim.

In other words, if there was an incident that required a claim after a change in use, the insurer may deny coverage.

Now the lender doesn’t want to take the risk that the borrower does something to void the insurance.  After all, a good piece of the lender’s security is the house on the land.  So, this is why the Standard Mortgage Clause was born.

It basically says that even if the coverage has been voided because of an act by the borrower, that policy is still in effect to protect the lender’s interest.  It’s almost like a mini stand-alone insurance policy for the lender that camps right onto the borrower’s policy.

Pretty exciting right? (Agree to disagree here.)  But it is extremely valuable to a lender. 

So, when you see that requirement, think of it like lender-grease (as opposed to a greasy lender) that removes the friction caused by insurance fine print.