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When you purchase a home, your monthly payment includes more than the property price. In addition to the loan principal, your payment will consist of interest and, in many cases, funds to cover property taxes and homeowners insurance. Even if you pay the latter expenses separately, your mortgage lender will likely require proof of insurance as a condition of issuing the loan.
Homeowners insurance provides a financial safety net for you and your lender if something goes wrong. An insurance policy protects you from risk and significant losses from events like destructive storms and fires, trip-and-fall accidents on your property, and associated legal issues.
Although many homeowners see insurance as an added expense, it’s a monetary safety cushion that provides extra peace of mind and security. Let’s examine all the ways that home insurance protects your financial well-being.
A homeowners insurance policy protects you against the financial losses that can arise from certain risks. It covers your dwelling (the actual house) and your belongings, as well as your liability from property damage for injuries that occur on your property.
Every insurance policy is different, but the typical one will pay for damage related to:
It will also pay medical and legal expenses and damages if someone sues you for something that happens on your property. In addition, if an event renders your home uninhabitable, your insurance policy will cover your living expenses while you get back on your feet.
Lenders typically require a policy to cover the cost of rebuilding the home based on its location, size, and building materials. This is not the same as the market value of the house. The policy will also cover replacing your belongings, typically at about 50% to 70% of the dwelling coverage.
For example, assume the insurance company determines the cost to rebuild your home at current prices is $500,000. If you experience a loss due to a covered peril, the company will pay up to $500,000 to rebuild your home after your deductible. You can also claim $250,000 to $350,000 (depending on the policy) to replace your belongings.
Ultimately, insurance helps make you whole again in the aftermath of a disaster. Even if a major storm or fire destroys your property, the bank expects you to pay the mortgage in full. With insurance, you can afford to replace your home without defaulting on the mortgage and dealing with the long-term impacts on your financial health.
Although homeowners insurance provides a financial safety net against many of the most common disasters, it won’t protect you against everything. Your lender may require you to purchase a separate policy for certain risks, or you may choose optional endorsements or riders to provide a money safety buffer.
Floods and earthquakes are two of the most common disasters not covered by homeowners insurance.
Standard home insurance doesn’t cover flood damage. If you live in an area FEMA designates as high risk for flooding, your lender will likely require you to purchase a separate flood insurance policy.
You may also need to secure earthquake insurance coverage if you live in an area prone to earthquakes. In California, where earthquakes are most likely to occur, homeowners usually purchase this coverage as a separate policy, but in other states, you can add it as an endorsement to your primary policy.
Other perils that a standard insurance policy won’t cover include:
You may include coverage to your policy for many of these perils as a fiscal protection net. For example, you can add an endorsement to cover sewer backups and sump pump failures, which pay for cleanup and repairs up to the policy limits. If you own high-value items, like original artwork, and the limits on your standard policy won’t cover the entire value, you can purchase additional protection through a valuables coverage policy or a scheduled personal property policy, which protects specific items.
Home insurance isn’t a legal requirement in any state, but mortgage lenders can make carrying a policy a loan condition. While insurance protects you from losses and ensures you can rebuild or replace your home and belongings, it also provides a financial safety net for the bank.
When you purchase a home with a mortgage, the bank has a financial interest in the property. If something were to go wrong, and you don’t have insurance to cover the losses, there’s a strong chance that the bank would also suffer losses. If you have insurance coverage, your lender has a guarantee of a payout and will sustain minimal loss.
You may notice that your insurance policy has a loss payee or mortgage clause. This means that when you make a claim, the reimbursement check could have your lender’s name on it in addition to yours. This is yet another way that lenders protect their financial interests against losses.
Once you pay off your mortgage, you do not have to carry homeowners insurance anymore if you don’t want to, unless your HOA requires it. However, the cost of a policy is minimal compared to what it would cost to replace your home and belongings.
If you have a mortgage and cancel your policy or allow it to lapse, the carrier will notify the lender. When this happens, your lender will allow you to secure new coverage or purchase a policy on your behalf (called force-placed insurance) and add the premium to your mortgage payment. In most cases, these policies cost more, provide less coverage than one you might purchase, and benefit the lender more than you, so it’s best to shop around and buy your own home insurance.
When you take out a mortgage, your lender may require mortgage insurance, also known as private mortgage insurance or PMI. This is in addition to homeowners insurance and is usually a requirement for buyers who put down less than 20% of the home price at the time of purchase.
While homeowners insurance covers damages or losses related to the physical property, mortgage insurance covers the loan. It’s an economic safety blanket for the lender if you default on the loan. If you stop making payments for any reason, and the bank forecloses on the property, they can make a claim on the mortgage insurance for the amount you owe and recoup their losses.
Some lenders require borrowers to carry this insurance coverage for the life of the loan, ensuring a financial backup plan in the event of a default. However, you may be able to cancel this coverage once you reach 20% equity; in other words, you make enough payments to cover 20% of the cost of the home.
Even in the unlikely event that your mortgage lender doesn’t require you to have insurance, if you live in a neighborhood with an HOA, you may be obligated to buy a policy. Some HOA bylaws include clauses that require residents to have insurance and may even dictate the policy amounts.
If your HOA requires coverage and you fail to produce proof, you could face significant consequences, including fines, lawsuits, and, in some cases, a lien on your home. Therefore, you must comply with community rules and regulations to protect your finances.
Even though fewer than 3% of homeowners insurance claims are liability claims for things like injuries, the average claim exceeds $20,000. Unless you have that much cash and are ready to pay out of pocket, you need the financial security backup insurance provides.
Most liability coverage starts at $100,000, but you can purchase additional coverage as an umbrella policy if you have substantial assets to protect. In either case, buying insurance can protect you against devastating financial losses and provide a cushion when things go wrong.
If you need help making sense of your homeowners insurance options and want to design a custom policy that provides an adequate financial safety net at a price you can afford, check out Insurdinary’s easy-to-use online quote tool. Simply enter the details about what you’re looking for and compare options from top-notch insurance carriers. When you’re ready to buy, one of our experienced agents will help you purchase the right policy.
Do you have more questions? Get in touch with the Insurdinary team and get answers to help find the policy that works for your living situation.