A mortgage is not forgiven or released when the mortgaged property is destroyed or badly damaged, and the debtor remains responsible for the payments. However, many lenders offer at least some relief, like putting payments on hold, especially for disaster victims like those of the recent Nor-Cal fire. However, relief may only be available to debtors who are currently up to date on their payments.
Because lenders have an interest in the mortgaged property to protect, they have a right to ensure the policy proceeds are used to make proper repairs. Indeed, the lender is typically named directly on the insurance policy, and the insurance company is typically required to make all claim checks payable to both the insured and the lender. The lender then has the right to control the release of payments if they approve the rebuild proposed. In no event should an insurance company make the claim check payable directly to a contractor performing work unless the insured and the lender have expressly agreed to that in advance.
In some instances the lender will even have the right to choose if the home is to be rebuilt at all. If a property owner is in default, a lender may apply the claim proceeds to paying off the mortgage balance instead of rebuilding if it determines that doing so is more economical. Most loan agreements have provisions that allow for that. There may be relief for the debtor, however, where the failure to make the payments is excusable.