How much homeowners insurance is required by mortgage lenders?
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Homeowners insurance is a financial resource that can offer a great deal of protection for both your house and your belongings. Not only does it cover you in a wide range of disastrous events, homeowners insurance is also required by lenders when you take out a mortgage. Explore in this article why lenders require this additional coverage when you purchase your home and what additional policies you may need in certain situations.
Why do mortgage lenders require homeowners insurance?
Homeowners insurance is required by lenders to make sure their investment is protected in the event of a catastrophe. If your home is completely flattened or irreplaceably damaged in some way, you’d have no incentive to pay off your mortgage for a home you can’t inhabit.
In that scenario, although an extreme example, homeowners insurance would cover the mortgage so that the lender can be repaid for the full amount you borrowed. If you’ve heard the term and wonder “what is hazard insurance on a mortgage,” it’s actually the same thing as homeowners insurance — it’s simply a terminology difference.
How much homeowners insurance do lenders require?
Lender mortgage requirements stipulate that your homeowners insurance policy covers the full replacement cost of the home. The insurance company should be able to provide you with an estimate based on your home. However, older homes may require a modified replacement cost policy to cover the cost of updated materials rather than using older methods or materials that are currently in the home.
Minimum coverage requirements
Lenders often have minimum requirements for dwelling coverage. That’s the amount to be paid out for structural damage caused to your home. In some cases, your lender may only require you to maintain a policy that covers your current mortgage balance. Dwelling coverage typically doesn’t apply to free-stranding structures such as a detached garage.
Your lender may also require that you include a mortgagee clause in your homeowners insurance policy. A mortgagee is the lender, whereas the borrower is considered the mortgagor. This clause is a separate contract between your insurance company and your lender that guarantees they will be paid in the event of a loss or claim made on the property. In some cases, this additional stipulation could ensure payment to the lender in the event you are responsible for the damage and are dropped from your policy.
Additional coverage requirements
Most standard homeowners insurance policies automatically include coverage for damage caused by theft, fire, hail, lightning and certain types of other natural disasters. Each policy may differ in terms of what’s covered, especially depending on where you live. You may need additional coverage in order to be covered in the following situations, some of which may be required by your lender.
Dwelling coverage: This is the main part of your policy covering your home’s structure and is required by lenders.
Hurricane or windstorm coverage: Most homeowners insurance policies do not include hurricane or windstorms. Depending on where you live, you may or may not be required to add-on this supplemental coverage. Check whether the hurricane policy covers damage from wind, flooding or both.
Flood insurance: Not everyone needs flood insurance, but your lender may require it if you live in a high-risk area. You can check FEMA’s Flood Map Service Center to determine whether or not your property is located in a flood area.
Earthquake insurance: Standard policies don’t typically cover earthquake coverage unless a fire is caused by a quake and damages your home. In that event, the resulting fire damage would be covered. Your lender may require additional coverage if you leave near a fault line or in an area with widespread oil drilling (such as Oklahoma).
Additional endorsements: You can add on a number of other endorsements to your homeowners insurance, depending on your lender requirements and your own preference of comfort level. Common endorsements include:
- Water backup and sump pump overflow
- Personal injury
- Other structures (such as sheds or a detached garage)
- Umbrella coverage (increases your liability coverage)
- Service line coverage (for any underground pipes on your property)
Talk to your lender about what they require. Also tap into your local insurance agent’s expertise about what they recommend for your specific area. You can always get multiple quotes to compare different suggestions.
Loss payee requirements
Many lenders require that they’re named a loss payee on your homeowners insurance policy. If you make a claim involving damage or loss on the home, the lender is included on the settlement check. The goal is to make sure you actually use the claim money for those necessary repairs, rather than filing a claim and going on a personal shopping spree. When your lender is a loss payee, you may need to get their approval before you make any payments on contractor services or supplies with the funds you receive.
Mortgage insurance vs homeowners insurance
Mortgage insurance and homeowners insurance are two completely different policies, although both may be required by your lender. Here’s what you need to know about each one.
Mortgage insurance provides you no protection but is designed to protect the lender when your down payment is less than 20%. The benefit to you is that it helps you qualify for a loan, especially since the average down payment amount in the U.S. ranges between 5% and 7% of the home’s purchase price.
The amount of mortgage insurance you pay depends on the type of home loan you receive. Oftentimes, you’ll pay an upfront fee at closing as well as an annual fee that’s paid monthly as part of your mortgage payment. You may be able to drop your mortgage insurance from your loan when you reach 20% home equity or you may have to refinance your mortgage completely.
Homeowners insurance, on the other hand, covers damaging events that occur on your property. Here are the most common coverage components of a standard policy.
- Your home’s structure
- Your personal belongings (you may need additional personal property coverage for certain items)
- Liability protection
- Additional living expenses (paying for your lodging in case your home isn’t livable while repairs are being made)
- Lenders require homeowners insurance (or hazard insurance) to protect their investment in your property.
- Additional coverage may be required depending on where you live, such as an area prone to earthquakes or flooding.