Once you get approved for a mortgage on a home, your lender will ask you to provide them with multiple documents so that you can officially close on the loan. One of these required documents is your proof of homeowners insurance, which ensures that your home — and the lender’s financial investment — is protected from perils like fire and bad weather.
Your lender will likely have “scope of coverage” requirements that detail what must be covered by the policy. At minimum, your policy will need to cover wind, hail, fire, and vandalism. Your policy will also need to contain a high enough coverage limit to fully replace your home in the event it’s destroyed in a fire or other disaster.
Why do lenders require homeowners insurance?
Lenders require homeowners insurance so that the property they have an investment in is fully covered against catastrophic damage. The lender also wants to make sure that, as the borrower, you’re financially capable of paying down the mortgage in the event that the home is destroyed.
Let’s take a look at an example.
Say your home is wiped out in a hurricane and you don’t have insurance. Your mortgage obligation wouldn’t simply disappear — you’d still technically be required to pay off the loan. But chances are you won’t continue to pay down the mortgage of a home that was destroyed, and foreclosure won’t be of much help for the lender as there’s no actual home to repossess and sell.
That’s why lenders require homeowners insurance prior to letting you take out a mortgage — the lender isn’t only protecting their investment, they’re also protecting you from yourself. And since home insurance coverage isn't included in your mortgage, you're responsible for taking out a policy yourself.
How much homeowners insurance do mortgage lenders require?
Many lenders require that your home be insured for 100% of its replacement cost, as their primary concern is making sure the home can be rebuilt from the ground up in the event of a disaster. In most cases, the insurance company’s coverage estimate will more than meet your lender’s minimum insurance requirements. You can also receive a more accurate estimate by getting a proper rebuild appraisal of your home or contacting local contractors, roofers, or construction companies.
However, some lenders may only require a coverage amount equal to the unpaid portion of your mortgage balance — but keep in mind that electing for this amount could leave your home vastly underinsured.
Mortgages secured through Fannie Mae, for example, typically require your homeowners insurance coverage amounts to be equal to the lesser of the following:
The full replacement cost, or insurable value, of the home as established by your insurance company
The unpaid principal balance on the mortgage, as long as it’s equal to at least 80% of the insurable value of the home as established by your insurance company
Homeowners insurance policy requirements
In addition to minimum levels of coverage and ensuring your home is covered against particular hazards, your insurance company may also have the following requirements:
Scope of coverage requirement
Your lender will require that the dwelling coverage portion of your policy protect the home against, at the very least, the following hazards:
Weight of snow, ice, and sleet
Damage from vehicles (not your own)
Riots or civil unrest
If your policy excludes any of the listed perils, your lender may instruct you to purchase a separate policy to fill that coverage gap.
The lender be named as a loss payee
Your lender will require that they be named as a loss payee along with yourself and whoever else is a named insured on the policy. That means that when you file a claim for damage or loss, the settlement check from your insurer is made out to both you and the mortgage company.
This ensures that the money you’re receiving from a claim is going toward repairs for a covered loss and protecting the lender’s investment. Your lender is required by your insurer to sign off on any home-related expense that your settlement check goes toward.
Inclusion of a mortgagee clause in the policy
Your lender may also require that your insurance company include a clause in the policy stipulating that your coverage can’t be canceled without a minimum of 30 days written notice to the lender and that they assume liability if there is no disclaimer.
Deductible amount requirement
If your policy has separate percentage deductibles for wind and hail or hurricane damage, your lender may require that the deductible not exceed a certain amount so that you’re not left paying too much out of pocket in the event of a loss.
Proof of coverage document
Your lender will also require proof of homeowners insurance, as well as any other type of insurance you may need before you’re able to close on the mortgage. Don’t delay looking for coverage and potentially jeopardize your ability to close in a timely manner. Most lenders will require proof of homeowners insurance — also known as an insurance binder — anywhere in the days, and in some cases, weeks ahead of closing.
Can lenders require any other type of property insurance?
It’s possible that your lender will require coverage to complement your homeowners insurance policy. The most common type of required supplemental protection is flood insurance, but your lender may have other coverage requirements as well.
Homeowners insurance typically covers damage from heavy winds, but insurance companies in exceptionally high-risk coastal areas may exclude wind from your policy. If that’s the case, your lender may require you to fill that coverage gap with a standalone windstorm insurance policy.
Wind-only policies can be purchased from surplus lines insurance companies, which are insurers that specialize in covering high-risk properties. In certain areas, windstorm coverage can also be purchased through your state’s FAIR Plan.
In addition to requiring homeowners insurance, most lenders will require flood insurance if your home is located in a high-risk flood zone according to Federal Emergency Management Association flood maps.