Rising home prices in the Dallas / Fort Worth area mean larger mortgages in most cases which raises an interesting question, “How much home insurance is needed when you buy a home?” Stated another way, should the amount of home insurance be equal to the purchase price, the loan value, or some other number?
I dealt with this question last week when wrapping up a home insurance policy for a person buying a home. After getting everything coordinated with the buyer and sending in the paperwork to the mortgage company needed for closing, the loan underwriter requested I increase the amount of coverage to equal the amount on the loan. Let’s examine all three numbers.
Purchase Price: There are two things every homebuyer buys when purchasing a home, the home itself and the lot it sits on. Both have a certain value and are combined in the home’s purchase price. Since the lot isn’t going to go anywhere, home insurance companies only insure the home, not the land. Liability coverage is extended to cover incidents which may happen on the lot, but the lot will never be lost to a fire, tornado, or even a flood. This means the amount of home insurance required should be enough to replace the home, excluding the land.
Loan Value: The loan value consists of the agreed upon purchase price for the home and lot less the down payment the owner pays, so even the loan includes some amount of money to purchase both. Most mortgage professionals agree if the home insurance is a replacement cost policy and covers either the loan value or the appraised replacement cost, they will accept a home policy for less than the amount of the loan.
The opposite case existed in 2009 through 2011 when home prices were depressed and the cost to rebuild the home was often more than the purchase price or the appraisal’s replacement cost. Even though home prices were depressed, the cost to replace them continued to climb due to inflation of building materials, lumber, windows, etc.
Replacement Cost: Insurance companies want to insure a home for the amount it costs to replace them if a total loss occurs (see http://wiseinsurancegroup.com/home-insurance-replacement-cost-actual-cash-value/). The amount of coverage should be enough to cover demolition cost, haul the debris away to the dump, pay whatever fees there are to do this, and build a new home (such as plans, fencing, EPA skirting, etc.).
To raise the amount of coverage if the replacement cost is lower than the loan amount means the client may pay for coverage they may not be able to take advantage of. To have too little, means the client won’t have enough to rebuild the home if a total loss occurs. The best amount is what will replace the home today and grow as inflation occurs so the homeowner does not become underinsured.
I requested a copy of the appraisal from the loan processor to see what their appraised replacement cost was. It turns out the replacement cost policy I recommended contained more coverage than the appraisal stated it needed. The loan underwriter approved my policy without any changes which meant my new client didn’t have to add needless extra coverage to their home policy.
What do you think? Share your comments, questions, and experiences with me on my Facebook, LinkedIn, and Google + pages. I’d love to hear from you!