What Does Homeowners Insurance Need to Cover in a Mortgage Loan?

Is There Such Thing as 100 Percent Financing on a Home?
October 6, 2020
How Much Does Private Mortgage Insurance (PMI) Cost?
October 20, 2020

What Does Homeowners Insurance Need to Cover in a Mortgage Loan?

Before taking out a loan to purchase a home, your lender will require that you get enough homeowner’s insurance to pay for the reconstruction of your home in the event of a fire or other significant damage, like a tornado. Most lenders require that you insure your home up to its replacement cost, and once you have homeowners insurance, you’ll have to provide proof of insurance to your lender before closing

What Must Be Covered Under Your Homeowner’s Policy?

Your lender and insurance agent will work together to make sure you have the right coverage. Typically, your policy will need to cover wind, hail, fire, and vandalism. Your insurance policy will also need to contain high enough coverage to entirely replace your home in the event of a complete loss. Mortgages secured through Fannie Mae generally require your homeowner’s insurance coverage amounts to be equal to the lesser of the following:

  • The full replacement cost, or insurable value of the home as established by your insurance company
  • The unpaid principal balance on the mortgage, as long as it’s equal to at least 80% of the insurable value of the home

Why Do Lenders Require Homeowner’s Insurance?

Lenders require homeowner’s insurance so that the property in their portfolio is fully Insured against catastrophic damage. In other words, they want to protect their investment. The lender also wants to make sure that as the borrower, you’re still financially capable of paying down the mortgage in the event of a total loss.

If a hurricane destroys your home and you don’t have insurance, your mortgage obligation won’t merely disappear. Technically, you’re still required to pay off the loan. But the lender knows that chances are you won’t continue to pay down the mortgage of a home that was destroyed, and foreclosure won’t be of much help for the lender because there’s no actual home to repossess and sell. That’s why lenders require homeowner’s insurance before granting you a mortgage. The lender isn’t only protecting their investment, but they’re also protecting you from yourself.

What is the Minimum Coverage Amount Required by Lenders? Most lenders will require that your home be insured for 100% of its replacement cost because their primary concern is making sure the house will be rebuilt from the ground up in the event of a disaster. Usually, the insurance company’s coverage estimate will more than meet your lender’s minimum requirements.  It’s also possible that your mortgage lender will only require a coverage amount equal to the unpaid mortgage balance, but note that electing for this minimal amount could leave your home vastly underinsured in the event of a major disaster.

If you still have questions about how homeowner’s insurance impacts a mortgage, or any other mortgage questions, call Primary Residential Mortgage. We are here for you and always happy to help. Give us a call today!