It applies to you. How to solve it?

As property prices rise, the risk of underinsurance increases. This can have unwanted consequences for you, but we have tips on how to cope and stay calm.

Clearly, the Moravian tornado highlighted the need to have proper property insurance. It is absolutely crucial to ensure that the property is not underinsured, meaning that it would be insured for less than its current value. It is not uncommon for the actual value of an apartment or house and the value stated in the insurance policy to differ by tens of percent.

If your property is not properly insured, i.e. underinsured, you are at great risk. If a catastrophe were to occur, the insurance company would pay you according to the amount of the sum insured stated in the contract, not the actual value of the property at the moment. This can lead to big problems, as in many situations it might not be enough to either compensate for the damage caused or to secure a new home.

Rising property prices cause underinsurance

There is nothing new in the fact that underinsurance of real estate is a persistent problem, which is exacerbated by the rapid rise in real estate prices in recent years. These prices can turn insurance policies taken out a few years ago into worthless paper, as the amount paid out, if necessary, might not be sufficient to cover the actual damage.

If the insurance policy was taken out several years ago, it may happen that, due to rapidly rising property prices, the value of the property increases many times and the insurance claim is no longer sufficient to cover the actual damage. So, for example, if you have an apartment insured for CZK 2 million, which is now being sold for CZK 4 million, and the apartment suffers damage worth CZK 1 million, the insurance company will only pay out half of this amount because it is based on the value of the apartment on the date the insurance policy was taken out. It is important to be aware of this fact and to bear in mind that in such a situation the property is not fully insured. When you are buying a property that is mortgaged, at some stage in the transfer your property must secure this foreign debt. This lien is a right in rem, which means that the fate of the thing that is encumbered will be shared with the buyer and will pass to them along with the property.

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How to sell a property with a mortgage?

It is important to consider how the buyer will finance the purchase of your property. If the buyer will be paying with their own funds, they will usually put the full purchase price into escrow and a portion of this amount will be used to pay off the mortgage once the transfer of ownership has taken place. This procedure provides the buyer with the assurance that, although the property is encumbered by a mortgage at the time of conclusion of the purchase contract, this mortgage will be released during the subsequent settlement of the purchase price and the buyer will thus acquire the property without any restrictions.

If the buyer is financing the purchase of the property partly with a mortgage loan, the process will be similar, but with the difference that the buyer's bank will not transfer part of the money into escrow, but will pay it directly to your bank to repay the mortgage. In this way, the buyer's bank will ensure that your old lien is effectively cancelled and its new lien will be first priority.

There is another important fact related to this procedure, namely the creation of a second lien on the property you are selling. The new lien is to secure the money the bank is lending to the buyer to purchase your property. Although this is a foreign debt (the buyer's debt to the bank) from your perspective, your property will at some stage serve as security for this foreign debt. While this may not be convenient for the buyer, mortgage practice does not allow for any other solution. On the other hand, this practice usually does not cause major problems because the lien is a property right and shares the fate of the thing it encumbers. Thus, once the title to your property is transferred, the new lien passes with the property to the buyer.

Correct timing saves nerves

It is essential to set the correct date for repaying the mortgage when you sell your property. This date will be different depending on whether the buyer is paying the purchase price from their own funds or from a mortgage loan. The bank will calculate all its claims on the required date in order to achieve the extinguishment of the mortgage on your property. The lien and the debt are accessory, so the lien will always extinguish together with the debt it secures.

You don't have to worry about selling a property that is encumbered by a lien because it is not a major obstacle. On the contrary, nowadays, selling a property offers interesting business opportunities that can help pay off not only the mortgage tied to the property being sold, but also second mortgages on other properties. If you have an existing mortgage with a fixed term that will end soon, this may seem like an interesting solution, especially given the ever-increasing mortgage rates.

It is important to remember that the sale of a mortgaged property requires careful planning and coordination between the parties and their banks to make the entire process successful. If you have any doubts about the planning or execution of the various steps, you should consult with professionals who can help ensure the smooth running of the entire process.

The author of the article Miroslav Pleva is a real estate attorney cooperating with a franchisee of the RE/MAX real estate agency network.