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How much home insurance does a mortgage lender require?

By Posted :

mortgage calculatorIf you're house hunting, or found your dream home already, you may be wondering: Do I  need to buy insurance before closing on the house? Homeowners with a mortgage must buy home insurance.

Mortgage lenders want you to protect your house in case there are catastrophic losses. They lent you money so you could buy your home and they still own a piece of it. They want to make sure you get enough protection so they won't lose out if your home is destroyed.

Homeowners without a mortgage don't need home insurance. This is different from auto insurance, which nearly every state requires.

That said, it's still a wise decision to have coverage, so your likely greatest asset is protected.

How much homeowners insurance does a lender require?

As we mentioned, states don't require home insurance if you have paid off your home. However, mortgage lenders require dwelling and liability coverage if you have a mortgage, but the actual homeowners insurance requirements for mortgage minimums depend on state law and company policy. There is no minimum coverage like auto insurance per se, said Elizabeth Enright Phillips, a former licensed property & casualty insurance agent and claims adjuster.

"There isn't a way to say, 'this is a dollar amount minimum' because of the wide variations of risk factors," Phillips said about a lack of standard minimum requirements.

While it is difficult to put an exact dollar amount on the required insurance amount (every home is different) there are some parameters that lenders require. In most cases, your lender will have a "scope of coverage" that details what insurance coverages you must carry.

These requirements can vary by lender and location of the home but almost all lenders will require that your home is insured for 100% of its replacement cost. They want to make sure the home can be completely rebuilt in the event it is destroyed.

Your insurance company will provide an estimate of coverages and this will usually more than meet the lenders minimum amount requirements.

Different lenders have entirely different requirements depending on the location, building codes, type of home, etc. Mortgage lenders' primary concern is that your home insurance protects against anything that can damage your (and their) asset. The lender cares about the home, but doesn't take into account the land, your belongings or other buildings on the property.

Mortgage lenders usually base the required level of dwelling coverage on square footage, local building cost data, type of home and may even use purchase price as a factor. They want to make sure that your home is fully covered so that if it's damaged, it can be replaced back to its current state and value.

"A mortgage company is going to look at square footage of the home and how much it will take to rebuild the home at that square footage at that particular location in that market," Phillips said. "It varies by mortgage company what they are going to consider as adequate coverage."

In some cases, a lender may only require that you carry enough insurance to pay off the balance of your loan. As an example, if you paid $300,000 for your home with a $60,000 down payment, your lender may only require you carry $240,000 in insurance.

While this works fine for your lender (they will be made whole) if your home is destroyed, you may not have enough insurance to actually rebuild your home. Most insurance experts recommend carrying enough coverage to completely rebuild your home.

Mortgage lenders also require liability insurance. Liability insurance protects you if you're sued or someone is injured in your home or on your property. Since your house is likely your most valuable asset, a plaintiff may go after your home. Your mortgage company has a stake in that asset, which is why they require at least a minimum level of liability coverage, which starts at $100,000.

Once the homeowners policy is in place, your mortgage lender likely won't require changes to the policy amount unless you add square footage or do a major renovation which would up the cost to repair or rebuild your home.

If at some point over the years you end up taking out a second mortgage on your home, you will likely face less stringent requirements for homeowners insurance. The second mortgage lender has a smaller investment in your home and will assume you already have the required coverage from your first mortgage.

Required perils

Your lender will most likely require that the dwelling portion of your policy protects against the following perils:

  • Fire and lightning
  • Damage from wind and hail
  • Theft and vandalism
  • Falling objects
  • Damage from weight of snow, ice, or sleet
  • Frozen pipes
  • Vehicles
  • Riots or civil unrest
  • Smoke damage
  • Explosions

If your policy excludes any of the listed perils for any reason, there is a good chance your lender will require you to find a separate policy to fill that coverage gap.

Is homeowners insurance included in mortgage?

While it may seem like it's included, it isn't. Your mortgage and homeowners insurance are two separate items. Often, your monthly mortgage payment also covers your homeowners insurance premium because your lender has set up an escrow account that handles your mortgage payment, property taxes and homeowners insurance.

Despite the fact that you may only make one payment per month, that money is split up between your mortgage lender, state taxes and your homeowners insurance company.

When does the lender require you to purchase the homeowners insurance policy?

Your lender should notify you of their mortgage insurance requirements prior to the closing and you will need to find a policy before closing. All lenders require homeowners insurance in place before you close on a house. You will be required to bring proof of insurance to the closing, this way the lender knows that their investment in your home is protected.

Is home insurance mandatory for mortgage?

Yes, if you have a mortgage on your home your lender will require that you have homeowners insurance in place. This is to protect their investment. They want to make sure your home can be rebuilt or repaired in the event it is damaged or destroyed. Your lender should notify you of their homeowners insurance mortgage requirements prior to closing so you can get a policy in place. If you own your home outright, you are not required to carry homeowners insurance.

What does home insurance cover?

Home insurance covers damage that's caused by fire, hail, lightning, vandalism and other covered perils.

Now, let's walk through the different types of coverage in a home insurance policy:

  • Dwelling: This pays you to rebuild or repair your home if it's damaged by a covered cause of loss, such as a fire.
  • Personal property: This covers what's in your house, such as furniture, clothes and electronics.
  • Loss of use: This helps pay your additional living expenses if you need to leave your house after it's damaged and while it's being fixed.
  • Liability: This covers you if you're sued or receive a claim against you or a member of your household. This could be because of causing bodily injury or property damage outside your property or if someone is injured on your property.
  • Other structures: This covers detached structures, such as garages, fences and sheds.

Other insurance requirements for your home

A mortgage lender may require additional coverage if your home is considered a risk. As an example, if your home is located in a flood zone or in an earthquake prone area you may have to put flood or earthquake insurance in place. Here are a few common additional coverages a lender may require:

Flood insurance: Standard homeowners insurance does not protect against flood or earthquake damage, but if you live in a flood zone, your mortgage company will likely require that coverage. Flood insurance policies can be purchased through the National Flood Insurance Program (NFIP) or private insurers. The cost of a policy varies dramatically depending on your properties risk factors. According to data from FEMA, the average cost of flood insurance is about $700 a year but that figure can go up dramatically if you live oceanfront or on the coast.

Windstorm insurance: While wind damage is covered by most insurance policies, there are insurers in certain areas (usually coastal or high risk for tornadoes) that may exclude wind damage from a standard policy. If this is the case, you will have to purchase an additional windstorm policy that would fill this coverage gap. Windstorm policies almost always come with a percentage deductible.

Earthquake insurance: If your home is in an earthquake prone area, your lender may require that you carry earthquake insurance. This is usually an added endorsement on your homeowner policy or can be a standalone policy. Earthquake insurance usually comes with a percentage deductible that ranges from 5% to 25%.

Additional endorsements: Your lender may require one or more additional endorsements to your insurance policy. A common request is water backup coverage which helps protect your home from water damage due to overflowing sewers or drains.

Other requirements your lender may require

In addition to specific coverage levels, your lender will likely require the following:

  • Lender named as a loss payee: The lender will require that they are named as a loss payee on the policy. Basically, this means that if you file a claim due to a loss or damage, the check from your insurance company is made out to both your mortgage company and you. This ensures that the money will be used to repair or rebuild the home, protecting the lenders investment in your home.
  • Mortgagee clause: This clause requires your insurance company to give your lender 30 days written notice before they can cancel your coverage.

  • "Force place" coverage: If your insurance is cancelled due to non-payment or any other reason, your lender can "force place" insurance on the property and you will be responsible for the new premium. Forced placed insurance tends to be very expensive.

  • Deductible amount: If your policy comes with a percentage deductible for wind, hail or hurricane damage your lender may require that the deductible not exceed a certain percentage, so it is still affordable.

  • Percentage deductibles: These can leave you responsible for a significant amount in the event of a claim. Percentage deductibles means that your deductible for a specific type of damage (wind and hail are common) is a percentage of the total coverage on your home. As an example, if your home is insured for $300,000 and you have a five percent deductible for wind damage you will need to cover $15,000 before your insurance kicks in to cover the balance.

  • Proof of coverage: You will need to provide proof of insurance coverage at your closing so make sure you do not wait until the last minute to find a policy.

How much home insurance do I need?

Mortgage companies require minimum coverage, but that's often not enough. Consider these factors when determining the right coverage levels for your home:

Rebuilding costs

At a minimum, your lender will require that your home is insured for 100% of its replacement cost. This simply means that your insurance levels must cover the complete cost of rebuilding your home to what it was before it was destroyed.

Your insurer will usually recommend coverage levels and those levels should be more than enough to meet the lenders requirements. If you would like a more accurate estimate of rebuilding costs you could get a rebuild appraisal done or contact a local contractor regarding rebuilding costs.

Factors that play into that include local construction costs, square footage and size of the home. The Insurance Information Institute (III) suggests one way to figure out how much homeowners insurance you need is to multiply the total square footage of your home by local, per-square-foot building costs, which you can get from your realtor, builders association or insurance agent.

There are additional factors that will impact rebuilding costs, including the type of home and materials, special features like fireplaces and number of rooms.

Personal property coverage

Homeowners insurance not only protects your home, it also protects your belongings. A policy usually provides between 50% and 70% of your homeowners coverage for contents coverage. As an example, if you are carrying $300,000 in homeowners coverage, you would have $150,000 to $210,000 in personal possession coverage.

A mortgage lender doesn't have a stake in your personal belongings so won't require this coverage, but you should still make sure you have enough coverage to protect your home's contents.

It can quickly get expensive if you have to replace everything you own so it is a good idea to take an inventory of your home's possessions to verify you have enough coverage. Expensive items (think jewelry, artwork, wine collections etc.) are often capped at around $1,500 so if you have luxury items that exceed this amount you may need to purchase a rider to up your coverage of those items.

Liability insurance

Liability insurance is the part of a homeowners policy that protects you against lawsuits and claims involving injuries or property damage caused by you, family members or pets living with you. A standard homeowners policy usually starts with $100,000 worth of liability insurance. In most cases, that will not be enough.

The specific amount you need depends on your situation and assets. If you own multiple homes in high-value property areas, you'll need more liability insurance than if you don't have many assets. Most insurance experts recommend at least $300,000 liability coverage.

Depending on your assets, you may even want to look into umbrella insurance, which offers additional liability coverage up to $5 million.

How much does home insurance cost?

The average cost of home insurance is $2,305 for a policy with $300,000 of dwelling and liability coverage, with a $1,000 deductible.

Your exact premium, however, will be based on where you live, the amount of coverage you choose, the type of material your home is made of, the deductible amount you choose and even how close your home is to a fire station. In other words, insurers look at a wide variety of factors when setting a premium.

You can get an idea of your homeowners insurance costs using Insurance.com's average home insurance rates tool. It shows rates by ZIP code for 10 different coverage levels.

Is home owners insurance a requirement?

Home insurance isn't required if you have already paid off your house. However, that doesn't mean you should drop coverage as soon as you pay off your mortgage. Your home is likely your biggest asset and unless you can easily afford to rebuild it, you should be carrying insurance regardless of whether you have a mortgage or not.

One of the best ways to lower your homeowners insurance premium is to shop around. Be sure to get quotes from multiple home insurance companies, most experts recommend getting at quotes from at least five different insurers. Make sure you are comparing apples to apples when it comes to coverage levels and deductibles. Finally, check into the company's reputation and read consumer reviews. An excellent place to start is checking out Insurance.com’s rankings of the best home insurance companies.The findings are based on a customer service survey of 3,400 policyholders.