Unlike auto insurance, there are no laws that require homeowners to hold home insurance. But mortgage lenders usually require homeowners to have a set amount of home insurance in place in order to protect their investment. While exact amounts of home insurance coverage required may vary from provider to provider, dwelling coverage is usually the key requirement.
If you bought your home with cash, a home insurance policy isn't mandatory. Still, it is the best, most affordable way to cover yourself in the event of a disaster. This article will cover:
- Why do mortgage lenders require home insurance?
- What home insurance is required by your lender?
- Do you need home insurance if you don't have a mortgage?
Why home insurance is part of your mortgage
Homeowners insurance is not required by state or federal law, but it's very rare for lenders to not include it as part of mortgages they underwrite. This is primarily done in order for them to protect their investment in the home.
A home is a large financial investment for both you and a mortgage provider, and they want to make sure that they can recoup their investment in the event of a loss. For example, if your house was gutted in a fire and not covered by home insurance, in the event of a foreclosure, your lender would own a big pile of ash with no value.
Mortgage lender home insurance requirements
Depending on your lender's requirements, the home insurance coverage and limits they have as underwriting conditions may vary. These variables can include specific peril coverage and payout structures.
One condition that is fairly frequent is that you will be required to name your mortgage provider as the loss payee on your home insurance policy. Lenders do this in order to stay in the loop to make sure that claim payouts go towards the required house repairs or rebuilding.
In terms of home insurance coverage requirements, the most consistent one is dwelling coverage, also known as "hazard insurance". Dwelling insurance protects the structure of your home. A mortgage lender's requirement for this particular coverage should be fairly obvious, seeing as their investment is tied directly to the home's structure.
Mortgage lenders usually require replacement cost payout rather than actual cash value (ACV). Replacement cost payout reimburses you on a claim in an amount equal to what is needed for full replacement of damaged or destroyed parts of your house. ACV pays out at the current value of the repaired or replaced item, minus any depreciation. ACV is usually a much less expensive home insurance option, but the lower payout doesn't really make it worthwhile. Mortgage lenders usually require replacement cost if:
- Your home is old: If you own an older house, an ACV policy will probably only pay out a small amount of what is required for a repair or replacement job.
- You live in a high-risk area: You will probably be requested to have replacement cost home insurance if your home is located in a designated disaster zone. Especially if you live in areas with a consistent history of floods, earthquakes and hurricanes, your lender may require you to get an extended replacement cost (ERC) policy. ERC covers the increase in costs for construction materials and labor that usually occurs after a natural disaster hits, covering the difference in cost from the original replacement value.
Riders on your dwelling coverage may be required in areas with specific perils if the limits of your standard home insurance are deemed inadequate. Be sure to compare home insurance quotes to make sure you get an insurer who can cover your lender's needs.
If for any reason your home insurance policy is canceled, your home insurer will notify your mortgage provider when the lapse occurs. Your mortgage company will require you to find a new home policy. If you don't, your lender is within rights to foreclose on your home.
If your policy is canceled due to failure to pay your premium or if you have too many claims, your provider will usually give you 30 days before the cancellation goes into effect. This should give you plenty of time to find new coverage in order to satisfy your lender's requirements.
What if you can't afford home insurance?
If for some reason the quotes you find are too far out of your budget to buy, look into your state's FAIR (Fair Access to Insurance Requirements) plan. FAIR plans are state-approved insurance programs geared towards providing home insurance to homeowners who cannot get affordable home insurance elsewhere. While the cost is often high in comparison to the low amounts of coverage given, FAIR plans are usually able to at least cover lender requirements for home insurance.
In rare occasions, and as a very last resort, your insurer may purchase home insurance for you if you don't find home insurance in an adequate amount of time. It is highly advisable that you do what you can to keep this from happening. Lender-placed home insurance can cost up to three times the cost of a standard home insurance policy, and may even offer less coverage for the cost.
Do I still need home insurance if I don't have a mortgage?
If you paid cash for your home and own it free and clear, there are no legal requirements for you to have home insurance. Even so, home insurance is an affordable way to avoid gigantic costs in the event of a disaster.
The average premium for home insurance is $1,215 a year. When you look at the amount of coverage a standard home insurance policy provides, the cost makes a lot of sense:
Dwelling: Dwelling coverage protects the structure of your home, as well as some external structures. Let's look at your roof as an example of the value a home insurance policy provides. Asphalt roofing is the least expensive of roofing materials, averaging about $90 per tile. Higher quality roofing runs into hundreds of dollars per tile. This means that a new roof can run tens of thousands of dollars, depending on the materials used. The cost of a home insurance policy is small potatoes in comparison.
Personal property: Personal property coverage provides protection for your belongings such as clothes, furniture, electronics and many other possessions. You may think you don't have much, but just doing an inventory of what you have in your bedroom closet can give you an idea of how much your stuff is worth. The recovery cost of those items probably overshadows a yearly premium.
Liability: Liability coverage helps take care of medical bills and legal expenses that can arise if injury or property damage to someone else is your fault. Most home insurance policies come with a minimum liability coverage amount of $100,000. While that seems like a lot of money, a long hospital stay or court case can tear through that quickly. It's normally recommended that you get $300,000 or even $500,000 in liability coverage if you have the budget for it. The cost difference between the minimum limit and higher limits is often not major.
Additional living expenses: If you have to relocate while repairs are being done to your home, ALE helps cover extra expenses that can accrue outside your regular living expenses. It usually helps to cover additional costs that can come with:
- Rent costs
- Restaurant meals
- Fuel costs due to extended commutes
If you're having major repairs done to the extent that you have to relocate, the repair costs alone will probably cost you a lot without home insurance. Out-of-pocket additional living costs are adding insult to injury at that point. A home insurance policy can help take your mind off extra expenses needed to live during the relocation.
Conclusion: home insurance isn't required, but you should buy it
Home insurance shouldn't be considered a necessity only because your mortgage provider requires it. The return on investment that a policy provides in the case of a large home repair or rebuild is immense, covering both your property and your peace of mind.
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