Homeowners’ insurance is one of those areas about which there is considerable misinformation, not just among the lay homeowner, but the realtors and mortgage brokers, alike. The purpose of hazard insurance as required by lenders is to protect their collateral or interest in the subject property. Only the structure(s) on the property are insured against fire, destruction or other damage, since the land is indestructible. Most borrowers will obtain a homeowners insurance policy which covers both the structure as required by the lender, and the contents, for their own protection. Yet, most lenders, brokers, and borrowers are misinformed about the extent of the coverage required. I have had any number of lenders steadfastly maintain that the required coverage had to, at the very least, be the amount of the loan on the property. THIS IS NOT SO. For example, on a $500,000 property with a $400,000 mortgage with the land value assessed at $200,000 and the home valued at $300,000 they (lenders) maintained that it was necessary for the homeowner to carry $400,000 of coverage even when full replacement value of the structure was only $300,000. As I mentioned a moment ago, such is not the case, in fact, there are laws against over-insuring properties. Many insurers have fallen victim to these laws in the past and have had to pay settlements because of their being in violation. The misinformation and half-truths that are disseminated in the area of real estate finance by well-meaning people is truly staggering and regrettable at times.
THE EXISTING RULE OF THUMB IS OFTEN MISLEADING
For years, many mortgage brokers approximated insurance premiums by multiplying the value of the subject property multiplied by a factor of .0035 and then dividing by 12. This equated to a cost of $3.50 per $1000 of insurance coverage or a factor of .35%. This amount was then divided by 12 (the number of months to arrive at the monthly premium). So, for a $500,000 loan X .0035 = $1750/12 = $145.83 per month in premium. In many instances it was a reasonably accurate approximation, but in others it could be wildly misleading. In California and other parts of the country, the land is valued at a premium. An 800 square foot shack on the beach might be priced at $3,000,000 but the replacement value of the structure might be as little at $100,000. Using the above formula would give a hugely inaccurate answer. Similarly, a lender who had provided a $2,400,000 loan to buyer to purchase said property and insisted on the buyer/borrower carrying $2,400,000 of insurance coverage (the amount of the existing loan) they would be guilty of requiring a borrower to massively over-insure their collateral.
PROPERTY MAY BE UNINSURABLE
When contemplating the purchase of a property, a necessary first step would be to have one’s realtor request a CLUE report from an insurance agent. CLUE, by the way, stands for Comprehensive Loss Underwriting Exchange. It is essentially a data base that the insurance companies maintain on insured property. The data base is a record of all the claims that have been made and/or paid out by insurers on properties and the insured’s names. The reason that potential buyers should obtain a CLUE report is because were they to purchase said property they might find it rather difficult, if not impossible to insure because of past claims on the property for say, water damage and its evil twin—mold. In fact, 85% of all homeowner claims are for water damage. In cases where there are repeated claims against the property, it is the property at that address that gets “dinged” or becomes uninsurable.
INSURED'S MAY BE UNINSURABLE
When there are repeated claims for liability or theft, the “dings” follow the insured in the belief that it is they who must have done something wrong as in attempting to perpetrate a fraud on the insurer. Accordingly, their premiums are increased or insurers decline to insure them.
UNDER-INSURANCE IS THE MOST COMMON MISTAKE WITH WATER DAMAGE THE MOST COMMON CLAIM
The most common mistake that homeowners make is that their property is under-insured. Most often this comes about because they do a room addition, often without being permitted, and they fail to notify their insurer of the add-on. If someone has spent $25-50,000 to add a room and then not get additional coverage to protect their investment it is a classic case of being penny-wise and pound-foolish. The cost of insurance coverage is relatively minimal. It is generally based on the square footage of the structure and its replacement cost. Discounts may be had for alarm systems, interior sprinkler systems and new roofs. Also, newer homes (10-years old and newer) typically have lower premiums.
VARIOUS TYPES OF COVERAGE
There are variations on a theme when it comes to insuring one’s property. One of the most common is umbrella coverage where both home and auto are insured by one company. Many people think that this type of coverage affords one discounts in terms of price, but it does not. It affords them greater coverage for the same price by raising the limits of one’s coverage on both auto and home at no additional cost. Thus, umbrella coverage, for the same premium, might raise one’s auto insurance coverage from a typical $300,000 to a million at the same time that it increased liability coverage for the property.
One cannot buy earthquake coverage without first buying a homeowner’s policy. The cost of the coverage is dependent upon the county in which the property is located. San Diego is fortunate in that its premiums are among the lowest for any county in the state. The amount of the premium is set by the state and it is usually about half the cost of homeowner’s coverage and matches the limit on the dwelling.
Construction coverage is purchased when one is building a home. It is a term policy of sorts, normally a year in length that provides coverage during the course of construction. Its purpose is largely two-fold: to insure against liability due to injury and to cover theft and damage to raw materials at the build site. It does not protect against shoddy construction, hence, the need for one to employ licensed contractors who are insured.
Most replacement policies cover replacing a damaged structure at the current cost of materials and labor. Built into the policy is what some term “shadow coverage” or extended replacement cost which provides for 25% beyond the normal cost of replacement. For a nominal sum one can purchase a policy with increased replacement cost up to 50%.
INSPECTIONS AND RATINGS
The re-inspection process is done annually by insurers. Something that may trigger a re-inspection sooner is one triggered by probable maximal loss. An example would be insufficient brush clearance around a property in a high fire risk area. It is also the biggest reason to re-inspect or deny coverage. The clearance norm may vary from as little as 200 feet to 200 yards, depending on the insurance company. In the past, this was done with a drive-by and a picture of the front (and back, if possible) of the property, but now things have gone high-tech with satellite photos.
Another type of inspection is the pre-binding inspection. This inspection is performed prior to insuring a property. It often takes a week or two. It is pretty much a given, provided the homeowner has not mislead the insurer by claiming the property to be larger than it actually is (insurers tend to go by square footage) or that the homeowner has not misrepresented material facts about the property, like claiming that the property had a tile roof instead a wood shake roof.
Insurance companies are rated by AM Best and Standard & Poors. The grading system runs from A to F, (A++ or A+ being best).
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