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When purchasing a home (whether your first or twentieth), one of the major considerations that must be undertaken is that of homeowners insurance. But many buyers, especially those new to real estate, fail to realize that there are actually several different types of insurance pertinent to home ownership – two that you'll definitely need and one other that could be required by your lender. They're listed here:
- Homeowners insurance (the kind that normally springs to mind) provides coverage for your home, possessions, and people on your property. It's required by your lender.
- Title insurance protects you against any problems with your claim to ownership, i.e. your title to the property. This also is a lender requirement.
- Mortgage insurance protects the lender in the event of your default on the loan. Depending upon how the purchase transaction is structured, you may or may not have to obtain this coverage.
Homeowners insurance
Most people prefer not to dwell on thoughts of the possibility of bad things happening, and that's certainly understandable. Unfortunately however, in this world, things do happen, and it's only prudent to be prepared. What's more, when financing a home, it's a requirement that you be prepared. All lenders demand fire, theft, and liability insurance to be maintained on properties that secure their loans. Additionally, depending on where you live, your lender may also require other types of coverage. For example, if you live in a designated flood area, you'll likely find it necessary to purchase flood insurance.
A homeowner's policy generally provides two types of protection. Casualty insurance (also called property protection or hazard insurance), covers losses or damages to the structure and contents caused by fire, theft, and certain weather-related hazards. Personal liability insurance provides financial protection in the event that you're sued by someone who sustains an injury while on your property. For example, if your friend Bessie (who's been known to knock back a few) comes over and, during a neighborhood get-together, does what she's wont to do and then and falls off your porch, you'll be covered. Further, family members may also be covered if they get hurt away from home. Your lender will want you to have both types of coverage; however, the amount of the coverage is up to you (above any minimum requirement, of course). You can also add other types of coverage.
The most basic homeowner's policy covers what are known as the 11 common perils, which are: fire or lightning; loss of property due to fire or other perils; windstorm or hail; explosion; riots and other civil commotions; aircraft; vehicles; smoke; vandalism and malicious mischief; theft; and the breakage of glass that constitutes a part of the building. More expensive policies include these basics and other areas. When deciding on the amount of coverage you need, be sure to consider the lender's minimum requirement, which is usually the property's purchase price less the value of the land. Any coverage above that level is optional to you.
The amount of insurance you need – and the premium that you pay for it – should be based on the cost of replacing the entire structure along with the value of your personal property. For example, your homeowner's policy may provide a total of $250,000 in coverage: $185,000 for the replacement value of your home and $65,000 to cover your personal property. Be careful to insure your home for its current full replacement value – not its market value. The current market value is what your house would bring if you sold it today. The current replacement value is the amount that it would take to replace your home today.
To estimate your home's replacement cost, multiply the square footage of floor space by the current construction cost-per-square-foot for similar homes. A local builder's association can provide you with this figure. For your possessions, simply make an inventory. It doesn't matter whether you use a video camera, a computer program or even pen and paper; you just need to get everything itemized. Once you figure a value for all of your personal property, find an appropriate insurance value, but keep in mind that you're likely to run into monetary limits for certain items. For instance, your insurer may set a $3,000 limit on jewelry and furs, so if you want to cover them for their full value you'll have to pay an additional amount. Also, be sure to update your coverage if market values change, if you get rid of or acquire more possessions, or if you make a major improvement to your home.
Shopping tips
Buying homeowners insurance can be a bit more involved than you might first think. The main things to consider are that you get enough coverage, that you keep your coverage up-to-date, and that you get the best coverage for your money. Don't fall victim to the temptation to slip by with the least amount of coverage you can get away with. Remember that this is your home you're protecting, so don't scrimp on the policy. If you're adamant about saving money, opt for a higher deductible instead.
Putting off buying your home insurance until the last minute can also be a trap. Since a policy must be in force at closing, you may be pressed into going with the first insurance company that you run across, and lose the opportunity to shop around. Rates can vary significantly from company to company and from area to area. And furthermore, while you're comparing rates, don't forget to ask about discounts. For instance, many companies may offer a price break if you insure both your home and car with them. You might also receive a discount if you install a smoke or burglar alarm or have a newer home.
When comparing policies, find out what will be covered and what won't be. If a pipe bursts and your basement sustains water damage, you'll need to know that your insurance company will pay for it. You'll also need to find out how damage benefits are paid – preferably the full replacement cost. For instance, if your roof is damaged, you'll want the insurer to cover the entire cost of a new roof – not just a partial amount. And you'll want to determine whether the policy is adjustable (some offerings are tied to the Consumer Price Index and rise accordingly – but you may pay extra for this feature).
Mortgage insurance
Mortgage insurance is required by lenders if you get an FHA loan or a conventional loan with a down payment of less than 20 percent. As a matter of fact, some states have laws that prohibit an 80 percent loan-to-value (LTV) ratio without mortgage insurance, and the secondary market generally will not purchase such a loan without it. The primary lender customarily buys and sets up the insurance, and passes the cost through to the borrower. For conventional loans, this coverage is called Private Mortgage Insurance, or PMI. FHA loans are backed by their own insurance program known as a Mortgage Insurance Premium, or MIP. They both operate in same manner; they help protect the lender against losses should the buyer default on his or her loan.
With an FHA loan, the mortgage premium that you pay provides insurance for the life of the loan and can be financed into the principal. So, if you sell or refinance an FHA loan, you may be entitled to a refund. For private mortgage insurance, you're generally required to pay for one year's coverage up front (at closing) along with a monthly charge, or you can pay one-time lump-sum premium amount. The size of the premium depends upon the down payment provided, the coverage required by the lender and the particular type of the loan (whether fixed- or adjustable-rate).
Additionally, the first-year premium rate is typically higher than for subsequent years. For example, your conventional loan may have PMI that charges a 1 percent premium the first year (which, again, must be paid up front) and then ½ percent each year thereafter. This amount is added to your monthly mortgage payment. For a $100,000 loan, your up-front PMI premium would be $1,000. The next year's premium (½ percent or $500) would be divided by 12 and added to your monthly payment. During the loan origination process, be sure to ask your lender to shop around for PMI insurance; the least-expensive offering is best for you.
Depending upon the loan agreement, you may be able to cancel the insurance once you attain a certain equity level. Once the principal balance falls below 80 percent of the value of the home, the insurance may no longer be necessary. Check with your lender about how and when you'll be allowed to cancel the coverage. But it's imperative that you request the cancellation in writing; the lender will not cancel the insurance automatically. The lender may also require that certain steps or conditions be met before agreeing to remove the coverage; such as a current appraisal if the property has been improved, a clean payment history (for instance, no more than one late payment of more than 30 days within the preceding 24-month time frame) and a minimum overall payment history (such as two years). Additionally, the lender will necessarily require that you still occupy the property.
Title insurance
Title insurance is purchased at closing and insures a clear and trouble-free ownership conveyance. (Some areas don't have title insurance but instead use another form of title guarantee, such as a title abstract.) Of course, trouble-free ownership does not mean that the plumbing won't go out or the roof won't leak. Here, "trouble-free" alludes to protection against any losses that might be incurred by the homebuyer should, for example, one of the seller's long-lost relatives suddenly appear with a solid claim to ownership of the property.
To guard against such eventualities, the lender will order a title search done (which the seller usually pays for). When a title search is performed, someone searches all of the records for a particular property and traces its history of ownership. The searcher starts with the current seller and works backwards from owner to owner until the very beginning – when the land was originally granted or sold. This person usually examines manually a large number of public records: deeds, court judgments, liens, death certificates, divorce decrees, tax assessor's and surveyor's information, wills, and whatever other pertinent documents are available.
A title search is meant to uncover not only the chain of owners, but also whether there are any easements, encroachments, or unpaid taxes on the property. An easement is a permanent right to use another's property. For example, the local electric company may have an easement to install and operate poles and power lines on some of your land. The water company may also have one. And if you share a driveway with a neighbor, you may both have an easement. An encroachment, on the other hand, occurs when something of yours is actually on your neighbor's property (or vice versa); if any exist, a title search should reveal them also.
If during the search, a cloud appears concerning the title, it must be cleared up. If there is a record-keeping error, it should be corrected. Or upon settlement, any party that holds a claim against the property can either release the debt lien or sign a quit claim deed. This type of deed relinquishes any right that he or she may have to the property.
Although the title search is intended to uncover any problems, it is not guaranteed. For this reason the lender goes a step further and requires title insurance. There are two kinds of title insurance policies available. A lender's policy is required by the lender. It protects the lender (and only the lender) against losses if any parties challenge the borrower's ownership right. For your own protection be sure to purchase an owner's policy, which protects you from financial loss if anyone challenges the results of the title search.
The cost of title insurance can vary by area and provider so, again, shop around. The premium is a single up-front payment that's good for the entire time you own the property. The cost of the search procedure and title insurance are often shared by buyer and seller; but remember, in real estate all things are negotiable.
