Insurance and Home Ownership

by Michael Licamele

Residential Finance Network does not offer any insurance products.

When buying a home for the first time, many consumers are utterly confused by the numerous types of insurance that they are required to purchase. At a typical closing in Massachusetts, a home buyer could pay for homeowners insurance, mortgage insurance, flood insurance, title insurance, mortgage credit life insurance and even earthquake insurance. In addition to trying to obtain the best coverage for the least cost, a buyer must know when and if they need each coverage.

Most consumers are familiar with homeowners insurance, which is also called hazard, fire or property/casualty insurance. This type of insurance protects the homeowner against physical perils such as fires, falling trees, windstorms and other disasters. In addition, most policies also provide general liability protection in case of accidents on your property. For example, if a neighbor came to visit, tripped on your broken front step and then went home and sued you, your homeowners policy would cover you.

One disaster that homeowners insurance policies do not cover is a flood. Because floods have caused such devastation in the past, private insurance companies stopped offering coverage. Many years ago, the federal government instituted the National Flood Insurance Program to assist homeowners with flood problems. Maps were drawn of flood zones in the country. These maps are available at local town halls. If your home is located in one of these zones and you are obtaining a mortgage, you must# purchase flood insurance from the federal government.

Another disaster that homeowners insurance does not cover is earthquake damage. While easterners may laugh at Californians who deal with earthquake threats daily, there have been numerous reports over the past several years of small earthquakes in the northeast United States. At present, this type of coverage is not required to obtain a mortgage. In addition, no damage has been reported due to earthquakes in the area. This is one peril that may become an issue in the future.

The second and most confusing category of insurance for home buyers is mortgage insurance. Mortgage insurance does not insure you, the homeowner, rather, it guarantees a portion of the mortgage to the lender in the event that the borrower defaults. This type of insurance is required when a home buyer is making a downpayment of less than 20% of the purchase price of a home. It is also required when a homeowner is refinancing and the amount of the mortgage loan exceeds 80% of the value of the property.

If mortgage insurance does not insure home buyers, the obvious question is why are they required to pay for it. Without this outside coverage, mortgage lenders would not be willing or able to offer mortgage loans with down payments of less than 20%. For example, mortgage insurance coverage has now allowed mortgage lenders to offer some mortgage loans with a down payment as low as 3%.

Because mortgage insurance coverage is an extra expense, and because obtaining the coverage requires two sets of underwriting approvals, many lenders have begun offering low downpayment loans with no mortgage insurance requirement. In exchange, however, borrowers must pay a higher interest rate on their mortgage. An experienced mortgage professional can help you determine which option is best for your needs.

The most important aspect of mortgage insurance that consumers must remember is that the coverage is not required for the life of the loan. In fact, you can remove your mortgage insurance coverage and stop paying the premiums any time after the second year you have at least 20% equity in your home. This equity can come from either an increase in market value or from paying down the loan. No lender will ever remove the coverage for you. You must make the effort to obtain a new appraisal at your expense and request that the coverage be terminated.

Many consumers confuse the mortgage insurance described above with mortgage credit life insurance. Mortgage credit life insurance programs charge a small premium each month and will pay off your mortgage loan in full if you die.

The last type of coverage that a home buyer must purchase is title insurance. Title insurance provides protection in the event that a flaw in the title is detected after the property has been bought. While attorneys conduct a title search to make sure that a seller is giving a home buyer a "marketable title," there are many instances in which small but expensive title issues may arise after closing. Lenders will require that home buyers obtain coverage for the mortgage amount, but additional coverage for the home buyers' equity is also available and highly recommended. The good news about title insurance is that it is a one-time charge with no annual premium.

One of the frustrating aspects of the home buying process is that consumers have little or no control over what types of insurance are required when they purchase their home. Homeowners insurance is always required in an amount equal to at least the loan amount (or for full replacement cost, which is extremely common). If your property is located in a flood zone, you will also be required to obtain flood insurance as well. At present, earthquake coverage is not required. Also, mortgage credit life insurance is never required and is simply an option for your financial planning. Finally, title insurance is required, but is only a one-time charge as stated above.

With a firm grasp of the many types of insurance, home buyers can confidently obtain the coverage they require, avoid programs that are not in their interest, and reduce their costs over the life of their mortgage loan term.

Michael Licamele is President of Residential Finance Network.