Most home equity loan or home equity line of credit (HELOC) lenders will demand that you have homeowners insurance on the home you are using as collateral. Here is what you should know regarding the homeowners insurance in as much as home equity loans are concerned.
What is a Home Equity Loan?
Home equity loan enables the homeowner to get a loan that is secured by the equity of the home. Equity is calculated as the existing market value of your home minus the outstanding balance of your mortgage. For instance, if your home is valued at $300,000 and you have a mortgage balance of $180,000 you have $120,000 of home equity.
In a home equity loan, the equity amount can be utilized to get a lump sum of fixed amount of money. Home equity loans like any other loans has a fixed interest and the period of payment ranges from 5-30 years.
A HELOC operates in a similar way, but instead, the borrower has the right to use funds up to a specific amount just like a credit card. Interest charges are only levied on the borrowed amount and not on the entire sum which makes the loans popular among many people.
Homeowners Insurance Requirements
Homeowners insurance is mandatory in most mortgage loans and the borrower is required to include the lender as the mortgagee. This also applies when you take out a home equity loan or line of credit secured by your home.
Here’s why lenders require homeowners insurance for home equity lending products:Here’s why lenders require homeowners insurance for home equity lending products:
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Safeguards the interest of the lender – In the event that the home is completely destroyed, the insurance amount can go a long way as far as clearing or at least minimizing what you owe your lender. This also assists in reducing the risk associated with the lending process.
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Avoid loan losses - Borrowers who are under insured are less likely to make loan repayments after a disaster as compared to those who are insured. Insurance money assist the borrower to restore and to make payments again.
- Mortgage requirements – Majority of the first mortgages that you take when purchasing a home will require you to have homeowners insurance. Lending products in the home equity market are backed by junior mortgages and therefore, lenders seek the same.
Lack of homeowners insurance will make the lender to buy the lender placed insurance for you at a higher price.
How Many Dollars of Homeowner’s Insurance is Required?
Most lenders expect adequate homeowners insurance to cover both the dwelling and also the replacement value of improvements. For home equity lending products, coverage amounts are sufficient where total coverage reaches and includes the combined loan amount of the first mortgage and home equity loan/HELOC.
For example:
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You have a $250,000 first mortgage and owe $50,000 on a home equity loan.
- Your lender may require that you have a minimum of $300,000 coverage for the total dwelling value.
Some lenders will accept coverage equal to 80 percent of DW and additional other property coverage only if the total of the loans will be covered by the amount of the coverage. Others apply certain minimum deductible limits like $500-$2500.
Carefully read your home equity lending agreement to understand your lender’s requirements on homeowners insurance.
Who to Insure Your Home
If you have homeowners insurance, ask your insurer to provide a coverage list and share information about your new home equity loan to ensure there is adequate coverage. In most cases, it is possible to raise liability and dwelling limits on your current policy without having to change carriers.
If you are without homeowners insurance or the policy you have will not suffice, compare quotes from different insurance companies. Like most financial products, homeowners insurance rates, and the conditions that accompany them, are not fixed and may differ from one company to another. Feel free to ask questions to ensure you get to know policy limitations, how to file for a claim, and other related matters.
Ongoing Homeowners Insurance Requirements
It is crucial to keep homeowners insurance for your home without gaps for at least the required amount by the lending institution when taking home equity loans. Avoid letting your policy lapse or not renew it due to failure to make timely payments.
Inform your insurer and lender instantly about any claim so that you do not get caught in any gaps that may cost you a great deal. Decrease of dwelling value from an uninsured calamity may also decrease the collateral securities of your home equity loan and can likely trigger technical default if coverage remains insufficient for a long time.
Pay attention to any changes in homeowners insurance renewal notices and report any upcoming policy changes that would affect your coverage status with your lender immediately, particularly nonrenewals. Your lender may force-place insurance if your insurance policy is canceled and that becomes very costly.
Look for cheaper policies occasionally, but do not change your insurance company unless the new policy complies with the requirements of your lender. Acquire new proof of qualifying insurance at any time you purchase a different policy.
You can also read more about maintaining homeowners insurance in the insurance requirements section of the home equity loan/HELOC agreement.
Key Takeaways
Home equity lenders always demand borrowers to maintain standard homeowner insurance policies that have minimum dwelling coverage of the combined loan amount. Real needs vary from lender to lender and depend on the loan details. Home equity lending documents should be thoroughly scrutinized, and the home equity lender should ensure that it continues to provide qualifying coverage constantly to avert noncompliance concerns in the future. Be sure to verify periodically, at least once a year, that your policy limits alongside the replacement value estimates are sufficient.
