When consumers apply for a mortgage loan, many discover there are several types of insurance they also need to buy. Here are the answers to some of the more common questions that borrowers ask about insurance policies.
Q. What is homeowner's insurance, and why do I need it to get a mortgage loan?
A. Homeowner's insurance, also called fire insurance and hazard insurance, reimburses the homeowner for physical damage, and in many cases lawsuits, against the property. It is highly recommended that every homeowner carry some type of homeowner's insurance to protect his or her investment. If you are borrowing money against your home, the home is collateral for the loan. In order to protect the loan's collateral, the lender will require the borrower have some type of homeowner's insurance. The annual cost of this insurance will depend upon the value of the property and the type of coverage chosen.
Q. What is mortgage insurance, and when would I have to pay it?
A. This is insurance that protects the lender against financial losses, such as borrower default. If you were to default on your loan payments, the lender could sell the home to recoup any losses. But if you put down less than 20 percent on your home purchase, the lender does not have much equity to fall back on if the home had to be sold at a loss. In these cases the lender will require the buyer to purchase mortgage insurance.
Q. How much does mortgage insurance cost?
A. Mortgage insurance is charged as a percentage of the loan amount borrowed. It depends on how much money you put down on the home. The lower the down payment, the higher the percentage will be. The percentage amounts are subject to change, but a borrower who puts less than 20 percent down could pay $40-$60 a month for mortgage insurance on a $100,000 loan. Once a borrower has 20 percent equity in the home -- through price appreciation, principal pay down, or a combination of the two -- he/she might be able to cancel the mortgage insurance, depending on the type of mortgage. Contact your lender to discuss this possibility.
Q. Why do I have to pay title insurance when I get my mortgage loan?
A. When a would-be borrower applies for a mortgage loan, the lender will check for any liens that may have been filed against the title of the property, for failure of the owner to pay taxes, home repair bills, legal judgments, etc. Sometimes a lien may not show up during the title search, but the lien-holder still has a legal claim against the property. Title insurance will offer protection against any undiscovered liens that may surface after closing. Depending on local custom, the seller may purchase this insurance for the lender.
Q. What is the difference between lender title insurance and borrower title insurance?
A. Since the property serves as collateral for the loan, lender title insurance will protect the lender's interest in the transaction. If there is a future claim against the property's title, lender title insurance will reimburse the lender for any losses incurred. The lender usually requires this insurance to be purchased. Borrower title insurance will offer similar reimbursement to the borrower, although the lender usually does not require its purchase.
Depending on local custom, the seller may purchase this for the borrower or the borrower can buy it.
Q. I've found out that I have to pay flood insurance before I can get a mortgage loan. What exactly is flood insurance?
A. Flood insurance reimburses property owners who incur losses when their real property and personal property suffer from serious water damage. Water damage might happen when normally dry land becomes soaked by large amounts of water. This could occur from accumulation of runoff surface water, from the overflow of inland or tidal waters, or from erosion caused by heavy runoff water. Since standard homeowner's/hazard insurance does not cover flood damage, flood insurance provides additional protection against loss. Flood insurance is available from various insurance agents.
Q. Why is flood insurance required?
A. The National Flood Insurance Program was created by the Flood Disaster Protection Act of 1968. This program makes flood insurance available through a joint program by private insurance companies and the federal government. This act was later amended to require that mortgage loans made by a federally regulated lender, government-backed home loans and most mortgage loans that are sold in the secondary market, have flood insurance protection if the property resides in a designated flood plain area. Homebuyers are encouraged to weigh the benefits of flood insurance even if the property is not located in a designated flood area.
Q. Do I need to purchase death or disability insurance when I get a mortgage loan?
A. Many mortgage lenders offer life and health insurance policies to their borrowers. A life insurance policy will pay off the mortgage loan in the event of borrower death, and a disability policy will make mortgage payments for the borrower in the event the borrower becomes injured and cannot work.
These policies are not required to obtain financing. Whether or not they should be purchased depends on each individual's family/financial situation and the borrower's current life/disability coverage through other policies. Borrowers need to shop carefully and compare the costs of insurance policies designed to pay off mortgage loans versus those for regular life or health insurance policies.