Buyers ask - Why do Lenders require Homeowners Insurance
Buyers ask: Why do Lenders require Homeowners Insurance?
Look at it this way: The home you want to buy is the mortgage lending institution’s “collateral” for the money they are lending you. So the reality of it is that the lender wants to protect their asset/investment. This just in case there is a catastrophe such as fires or a natural disaster and/or an accident in which the house is somewhat damaged or completely destroyed. So until you pay-off your mortgage in full, your lender has a financial interest in your property. Think of it as being similar to when you go buy a car and have it financed… believe me the lender will ask for full coverage insurance.
Therefore, as a condition of making the loan, your mortgage lender will require you to purchase a certain “minimum amount” of homeowners insurance that will protect both you and the lender. Most banks and lenders require that homeowners buy enough insurance, at the minimum, to cover the amount of their mortgage/Loan amount. Also to include coverage that also provides liability coverage for injuries incurred by visitors at your property. The amount of money your home is to be insured for is called the "dwelling limit coverage" (DLC).
You as the “financing” buyer need to simply know that during the Escrow process or a few days before the Closing-of-Escrow you will be asked, by Lender, to submit proof of this insurance coverage. The upfront buyer paid coverage period will be about 15-months in total (at least 1-year plus 2-3 months to the escrow account). The homeowners insurance is always paid 1-year upfront, same as your property taxes are paid in advance. And buyers to acknowledge that most always the insurance coverage to specifically state that the “Lender is named as Loss Payee”.
Is homeowners insurance a settlement cost?
Yes, it appears on the Good Faith Estimate as an estimated amount, and the actual amount is shown on the HUD1 document. HUD1 is the “detailed” closing document that lists all settlement costs.
Although homeowners insurance is not a mortgage cost, Lenders adamantly state that their "minimum insurance requirements" must be met before they will fund/approve the buyer's loan.
Myth's about Homeowners Insurance Coverage
Myth # 1: Is that a lot of a homeowners think that "all" personal belongings are covered. Please know that most all homeowner’s insurance policies are not designed to cover everything. Read your policy carefully because each policy clearly states what's covered and what's not. Personal valuables are covered up to the standard/basic coverage $dollar amount. Items that are not typically covered by a basic policy are personal valuables such as expensive art and/or artwork nor fine jewelry inside your house. It is highly recommended that you also acquire an additional coverage/policy to cover these higher valued personal items. Remember that the lenders most important item is whether the house and property are adequately insured.
Myth # 2: Is that homeowners insurance coverage should be based on the “market value” of a home. It is found that about 52% of buyers believe they should purchase insurance coverage based on their home's market value. However, with most insurance policies, rates are based on the cost to “rebuild” the home - not the value of the property. The reality of this is that the value of your home may be less than the actual cost to rebuild it from the ground up. And what if construction costs were to rise as property values start to fall. Therefore, it is important to incorporate the cost of a complete rebuild in your coverage.
Myth # 3: Is that “flood coverage” and “earthquakes” are included in most standard policies. Flood & Earthquake coverage typically are not included in standard insurance policies. Homeowners who live in an area that is prone to flooding or earthquakes most likely will be required to purchase a separate policy to protect themselves. Separate flood insurance is available from the National Flood Insurance Program and some private insurers. Even homeowners who live outside flood & earthquake zones may be wise to consider buying this extra protection.
Oscar Castillo : Broker Associate (San Diego, CA)
- Residential Brokerage