6 Things You Need To Know About Insurance and Your Mortgage
Money Crashers7-minute read
March 18, 2021
Purchasing a house is exciting, but it can also be scary because of the arcane and complex financial and insurance issues.
Your mortgage could cost you thousands of extra dollars over the loan’s lifetime because of interest rates, private mortgage insurance, homeowners insurance, and whether or not you refinance. For example, extra fees of $50 a month on a 30-year mortgage costs more than $10,000.
This is a complex topic with many exceptions. A complete analysis can (and has) filled entire classes and books. But here are six essential things you must know before signing a mortgage or refinancing your house.
Insurance And Your Mortgage: The Basics
1. Homeowners Insurance
This is what most people think of when they hear about insurance and mortgages. Your homeowners insurance policy covers your home against damage ranging from a broken window to a catastrophic house fire. Most homeowners policies also covers liability if somebody gets injured on your property and theft of items from your automobile or other vehicles.
When you get a mortgage, you’ll be required to prove you have an active homeowners insurance. This protects the lender. Your home is the collateral on your mortgage, and if that home is destroyed, they have no recourse if you default on the loan (which may be necessary after suffering that kind of financial loss).
Your homeowners insurance rate is connected to the assessed value of your home. You can reduce it by carrying multiple policies with your insurer to get a multiline discount, and often by setting up an automatic payment on the bill. A few other things you can do to impact your homeowners insurance rates include:
- Remodel and renovate carefully. Your insurance rate is based on the value of the home. Increasing the value can increase your rates.
- You may want to avoid pools and trampolines, which have high injury rates and expose you to lawsuits.
- Be cautious about a home-based business where customers come on-site because companies are sued more frequently than individuals.
- Remember, wood-burning stoves and fireplaces increase the risk of fire.
- Keep a careful eye on your credit and claims history, which can increase your rates if they’re bad.
- Installing burglar alarms and other safety equipment is beneficial.
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2. Mortgage Insurance
You may have heard about this kind of policy from your credit card: If you become unable to work (or sometimes even laid off or fired), the insurer will cover your minimum payments until things get better and you can make your payments again. Mortgage insurance is the same product, only for your mortgage. If you lose your job or your ability to work, the insurance will cover your mortgage payments until you’re earning again.
Most lenders don’t require mortgage insurance. If you’re working with a lender who does, it’s a sign you should do business with a different lender. It’s a product you might choose to purchase yourself to protect your investment, but generally speaking, experts say mortgage insurance is an unnecessary expense. You’re better off saving the money you would spend on it and setting up an emergency fund.
The only exception is if you have a health issue, work in a precarious field, or live someplace that suffers from sweeping layoffs regularly. These situations make it more likely for you to lose your ability to earn, making the insurance a better investment.
3. Insurance Escrow Account
Earlier, we mentioned that lenders require proof that your homeowners insurance is paid in full. If you pay your policy off in a lump sum annually and provide evidence of that at the beginning of each year, your lender will usually accept that as proof, and you’ll be good to go. However, not everybody can pay a multi-thousand-dollar annual premium all at once, and a lot of us don’t want the hassle of faxing in the proof every year.
Most mortgages use an escrow account to manage homeowners insurance. Each month, an amount equal to 1/12 of your annual homeowners premium gets added to your mortgage payment. That money goes into an escrow account and accumulates monthly until the premium comes due. Once it’s due, the mortgage lender uses it to pay the premium.
For most families, this works out fine. You get to choose your insurer, and the situation doesn’t impact your rates. It makes the entire process automatic from your perspective, so it’s more comfortable without costing extra money.
Two other things you should keep in mind when dealing with an insurance escrow account:
- Most mortgages will also do this with your property taxes to protect themselves against tax foreclosure.
- If you don’t set up your homeowners insurance within a specified time, your lender has the right to purchase your insurance for you and add the cost to your bill. This insurance is usually much more expensive than if you bought it on your own.
4. Private Mortgage Insurance
Mortgage insurance protects you if you become unable to pay the loan. Private mortgage insurance (PMI) protects your lender if you become unwilling to pay the loan. It does you no good but covers their losses if they’re forced to foreclose.
PMI is expensive, and there’s no reason you, as the borrower, should get it voluntarily. However, lenders may require you carry PMI before approving your loan if you’re:
- Borrowing more than 80% of the home’s value
- Borrowing with a low credit score
- Borrowing with a debt-to-income ratio below a certain threshold
- Borrowing without clear proof of income, such as self-employed earnings
- Borrowing certain kinds of loans, especially those available through HUD (these require PMI for the first few years of the loan)
Your insurer will purchase the PMI and add it to your mortgage payments, so you’ll have no control over how much it costs. However, you can make sure you get out of the PMI as quickly as possible by understanding two factors:
- What exact situation requires the PMI
- The process for eliminating the PMI once the situation is gone
Once you understand those two things, do everything you can to eliminate the first factor. Once you’ve done so, begin the process of removing this unnecessary cost from your life. It’s important to note that on an FHA loan, mortgage insurance premium (MIP) is added to the loan and cannot be removed unless there’s a minimum 10% down payment, in which case the MIP comes off after 11 years.
5. Life Insurance
Life insurance interacts with your mortgage in three crucial ways.
First, if you have life insurance with a company that also offers homeowners insurance, you can usually qualify for a multiline discount that reduces both policies’ costs. The discount is larger if you also include auto, long-term disability, or other policies.
Second, if you’re shopping for life insurance, you can use your mortgage payoff amount as a good baseline for how much you need. Different sources will offer various recommendations for how large a life policy to buy, ranging from just enough to cover funeral costs to five times your annual salary or higher. Many families can do OK financially if both spouses have sufficient coverage to pay off the mortgage, thus removing the most considerable expense from their monthly budget.
Third, you may be approached (by your lender or a third party) with an opportunity to buy a mortgage protection life policy. This is just term life insurance with a fancy name and usually costs more per dollar of coverage than other options. If you’re interested in this coverage, do some aggressive comparison shopping before you sign up.
6. Items Not Usually Covered On Typical Policies
When you insure your home, it’s important to remember that every homeowners policy will explicitly state that it doesn’t cover your losses for specific situations. This starts with your deductible (the amount you have to pay out of pocket before the insurance covers the remainder). Any claim for less than that amount is technically covered, but you don’t get a payout from your insurer.
Beyond that, some types and sources of damage are commonly left out of homeowners insurance policies:
- Long-term water damage from leaks, which insurers consider your fault for neglecting for long enough to cause harm.
- Flood damage, especially in areas where flooding is expected. If you’re buying a house in such a place, you can purchase independent flood insurance from the government.
- Earthquake damage, especially in areas where earthquakes are common. As with the floods, consider buying independent earthquake insurance.
- Damage from war and civil unrest. Many policies exclude this unlikely situation.
- Any damage caused by lack of maintenance to your home, since you could have prevented the damage.
- Damage from sewer backups, though you can usually press the sewage company (or your city if it’s a public utility) for compensation in this case.
- Negligence on your part that causes a lawsuit against the liability protection in your homeowners policy.
- Liability from a canine attack if your dog is an identified “aggressive breed.”
- Expensive jewelry, art, or other collections. Your policy will have a maximum coverage amount for such items. If your collection exceeds that value, you may want to buy a rider to cover the difference.
This article is a first step in learning about the complexities of insurance and how it interacts with your mortgage. We don’t have all the answers here. That said, with the information you now know, you should be able to ask the questions that will help you decide the best course of action for your home and family.
Ask those questions before you get your mortgage, refinance, or adjust your insurance policies. If you don’t get immediate, clear, complete answers, it could be a red flag that you’re doing business with the wrong people. Those professionals are there to help you understand everything you need to know.
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