More on Home Insurance
More on Home Insurance
Published September 21, 2018
TABLE OF CONTENTS
Homeowners insurance provides financial protection for your home and personal belongings from damage or theft, but it isn't legally required. However, after you close on a new home, your mortgage lender will typically require that you buy a homeowners insurance policy as terms of the mortgage before they help you secure the purchase. If you're able to pay for your home in cash up front without a mortgage, you don't have to get homeowners insurance -- but it's a good idea to have anyway.
Like disability and life insurance, homeowners insurance isn’t legally required, but mortgage lenders are well within their legal rights to require clients to buy a policy before allowing them to take out a loan on their house.
In the case where you haven’t been paying your policy premiums, your insurer will inform your mortgage company, who will instruct you to pay up or find a new policy. If you’re unwilling or unable to do either, your lender is within their legal rights to foreclose on your home.
Flood insurance typically isn’t required either, but if you live in a coastal community susceptible to hurricanes or if you live on a floodplain, the rules change a little bit.
Flood insurance is administered and regulated through FEMA and its National Flood Insurance Program (NFIP); these administered plans are then offered by private insurers. If your home falls in a high-risk flood area and you carry a mortgage from a federally regulated or insured lender, your lender is legally mandated to require flood insurance for your property.
There are a host of reasons why mortgage lenders require you to buy insurance before lending you a bunch of cash, but perhaps the top reason is they want you to be in a viable financial position to repay your mortgage (their investment) after disaster strikes.
If an unforeseen storm came through and flattened your home and you didn’t have insurance, you would be paying hundreds of thousands of dollars out of pocket to rebuild your home before you’d even consider paying a mortgage on a house that doesn’t exist or is uninhabitable.
If the home is wrecked and isn’t covered, the mortgage has little to no value, so threatening foreclosure isn’t much of a threat at all since there’s not much left to repossess and sell.
Depending on your lender, they may specify to you and your agent what kind of components you need in your policy and minimum coverage amounts for each; but they could also require a specific payout structure, certain hazards that need coverage, and they’ll stipulate that they be named as a “loss payee” on your policy in order to move forward with your mortgage.
While payout specifications aren’t too common, lenders may require that your policy’s payout structure be based on the replacement cost value (RCV) of the loss rather than its actual cash value (ACV). That means that when you incur a loss on damaged property – like a tree falling on your roof – and you file a claim and the damage is assessed, your claim check will reflect the current prices of roofing materials and labor to pay for the rebuild. Actual cash value policy checks are only as much as your roof’s value at the time it was damaged, so if it’s 10 years old, the roof’s value (and your claim check) could be significantly less than current roofing prices.
A couple occasions where lenders may instruct you to acquire a RCV policy rather than ACV policy are:
If your home is ancient and hasn’t had any modern cosmetic or structural improvements since the era it was constructed, an ACV policy would only pay to replace damage after 80 or so years of depreciation is accounted for. That would leave you with a depressingly small claim check and you’d have to cover the rest out of pocket. Mortgage companies may view the risk of loaning you money when you have an ACV policy similarly to how they view the risk of loaning you money when you have no insurance at all – in both cases their investment isn’t well protected.
If your home is in an area susceptible to natural disasters like hurricanes, earthquakes, mudslides and floods, your lender may suggest your payout be based on the extended replacement cost (ERC) of the materials or labor. Like RCV, this is generally not a lender requirement, but when disaster strikes and the cost of materials and construction sees an expected spike in price, ERC policies makeup whatever percentage-increase there was from the initial replacement value.
All lenders will require federal flood insurance if your home is located in floodplain areas “A” or “B”, which is a FEMA designation that indicates that the conditions are ripe for flooding. Lenders may even require flood insurance if the home is located in floodplain “C”, which have less flood propensity but are still at-risk areas.
Lenders may require that you supplement your hazard insurance (dwelling, other structures, personal property, and loss-of-use coverage) with riders or additional coverage types that protect against specific perils.
Depending on where you live, your lender may instruct you to add earthquake or hurricane insurance. They also may indicate certain riders, like water backup coverage, that you need to add to your policy. Check with your insurer to see if certain lender-required riders are available, or speak with a licensed representative at Policygenius, who can ensure you’re getting the coverage you need.
Your insurer will require that your lender must be named as a loss payee along with yourself. That means that when you suffer a loss and file an accepted claim, the claim check is made out to you and your mortgage lender. You’ll still be covered, but your lender must sign off on the check to ensure that the expenses are going toward covering the loss and not your dream vacation in Bali.
Your insurer can cancel your policy for a number of reasons – maybe you stopped paying your premiums, maybe you filed too many claims and aren’t viewed as a worthwhile risk, or maybe they just don’t like you personally (probably not the reason, because you’re great). We know that most mortgage companies require insurance, so what happens when you’re in policy limbo?
Your insurance company is required to give you and your lender 30 days notice before your policy’s cancellation takes effect, so worry not, you still have time to purchase insurance through a new company.
Check the status of your homeowners insurance comprehensive loss underwriting exchange or CLUE report, which details your claims history and is used by insurance companies to determine your risk. They may reject or deny your application based on that information. You can get a free copy from the legal database Lexis Nexis.
If you have a less-than-stellar claims history, prospective insurers will take note of that and you may have a difficult time being re-insured under a standard policy. That’s where Fair Access to Insurance Requirements or FAIR plans come into play.
A FAIR plan is a state-sanctioned insurance program that offers policies to high-risk applicants who would otherwise be turned down. The downside is that these policies generally cost more and offer fewer coverage options. Contact your agent to see if you qualify for high-risk insurance.
Lender-placed insurance is a last resort move by your mortgage company if you’re not acting fast enough to get insured. However, it's not as great as it sounds, as your monthly mortgage payment will be increased, and lender-placed insurance is typically two to three times more expensive than traditional homeowners insurance and may not offer riders or certain policy provisions.
Pat Howard is a homeowners insurance editor at Policygenius in New York City. He has written extensively about home insurance cost, coverage, and companies since 2018, and his insights have been featured on Investopedia, Lifehacker, MSN, Zola, HerMoney, and Property Casualty 360.
Pat has a B.A. in journalism from Michigan State University.