Must a financial institution holding a note and deed of trust on residential property pay interest on insurance proceeds which it has received from the borrower’s insurer?
The short answer is: “Yes, probably.”
A standard-form deed of trust with respect to residential property usually includes language requiring the borrower to maintain casualty insurance on the property. The deed of trust also usually specifies that in the event the property is damaged and the insurer pays on the policy, the borrower is to turn over the insurance proceeds to the lender while it is determined how the funds should be used.
California Civil Code ยง 2954.8(a) provides that a financial institution must pay the borrower 2% simple interest per annum on funds which it holds “for payment of taxes and assessments on the property, for insurance, or for other purposes relating to the property.”
Banks generally argue that section 2954.8(a) applies only to routine deposits of funds to pay property taxes, insurance, and the like. But the statute doesn’t include language limiting its application to only those types of escrowed funds. Federally chartered banks may argue, and have argued, that section 2954.8(a) is preempted by federal law and therefore not applicable to such banks.
There do not appear to be any reported appellate cases in which either of these issues have been decided. However, there is at least one superior court case in which the court concluded that the was obligated to pay 2% interest on insurance proceeds it held.