California legislature passes bill that gives interest on insurance payouts to homeowners

The California state legislature passed a bill Monday that ensures homeowners, not lenders, receive at least some of the interest on insurance payouts for homes destroyed or damaged by natural disasters.

The legislation comes after thousands of homeowners lost their residences in January’s historic wildfires in Southern California. Following such a loss, insurers send checks typically made out jointly to both the homeowner and the mortgage lender or servicer. The lender will then deposit the funds into an escrow account, where it earns interest that the lender could keep.

California Assemblymember John Harabedian, D-Pasadena, the author of the bill, said he is fighting to change that after hearing from his constituents about their struggles getting insurance payouts released from their lenders.

“If the homeowners are not given their money right away, the interest on that money, which the banks and the mortgage lenders are holding onto and earning [interest on], should be paid to the homeowner, not the banks,” Harabedian told CNBC. “The more we looked into this, the more we realized that this was a huge problem across the board.”

The bill will now head to Gov. Gavin Newsom’s desk to be signed into law.

After a disaster, insurance settlement checks can often be held in an escrow account by the mortgage servicing company until rebuilding is complete, which can take months or even years. During this time, the funds can accrue significant interest that the servicing company could keep.  

Now, the homeowner will be guaranteed at least 2% interest on those funds.

The bill will apply to both existing insurance payouts that are still being held in escrow accounts and to any new escrow accounts that are opened following a catastrophic event. For any funds already in an escrow account, interest at 2% simple per annum will begin accruing on the bill’s effective date.

Newsom, who sponsored the state legislation, said homeowners rebuilding after a disaster need all the support they can get.

“This is a commonsense solution that ensures that [homeowners] receive every resource available to help them recover and rebuild,” Newsom said in a statement in February when the bill was first introduced.

California law had already required lenders to pay homeowners interest on escrowed funds for property taxes and insurance, but it didn’t explicitly include insurance payments. The bill aims to close that loophole.

“It’s sad that we have to introduce a bill to make the banks and the mortgage lenders do the right thing, but this is about homeowners getting all the financial help that they can throughout this difficult period,” Harabedian said.