Does homeowner’s insurance pay off your mortgage if the house is lost? When you borrow money from a financial institution for the purpose of financing a home, the lender has a security interest in your home until the mortgage is paid off. Typically, the lending institution will require that you insure the home for at least the outstanding balance of the loan. They will also typically require that your insurer name them as an additional insured. If you fail to provide evidence of this insurance to your lender, your lender usually has the right, under the terms of your loan, to put insurance in place and bill you for it. This “lender placed insurance” is usually much more expensive than the insurance you would purchase yourself, and it may also be inferior coverage vs. what you could purchase on your own.
If your home sustains loss or damage that is covered by your Homeowner’s Insurance policy, and you purchased replacement cost coverage and sufficient limits of insurance, your Homeowner’s policy will cover the cost of your repairs (minus your deductible and any excluded property). If your home sustains a total loss, and you elect not to rebuild the home, your lending institution has a security interest in the loss settlement from your insurer that is typically equal to the outstanding balance on the loan plus any accrued interest or penalties.
An example: Sue owns a home that has a market value including the land of $500,000. The home itself has a replacement cost value of $400,000. Sue has been in the home for many years and the outstanding balance on her mortgage is only $100,000.
Sue’s home burns to the ground, as a result of a covered peril, and is a total loss. She had purchased Homeowners Insurance on a replacement cost basis and she had purchased a limit of $400,000. If Sue wishes to rebuild the home, her insurer will cover the $400,000 cost. If she elects not to rebuild, her lender will have an interest in the loss settlement check for the outstanding loan balance of $100,000, plus any accrued interest, fees or penalties.
Any amount remaining from the insurer’s loss settlement payment after the lender has been paid will be Sue’s.
When you elect not to rebuild after a total loss, depending upon the state that your home is in, it may impact the amount of money you receive from your insurer. Even if you purchased replacement cost coverage, many insurance policies only cover the actual cash value of the home (typically defined as cost to replace new with like kind and quality minus depreciation) if you fail to replace it, fail to replace it within some specified period of time shown in the policy, or you elect to replace it at a different location. For a discussion of adequate rebuilding limits adequate rebuild limits.
However, some states have laws on the books that require the insurer to give you replacement cost or the policy limit in the event of a total loss, even if you elect not to rebuild. Some states have “Valued Policy” statutes on the books that dictate how an insurer must handle a total loss.
You will need to read the terms of your insurance policy to see if loss payment is reduced to actual cash value in the event that you elect not to rebuild or you elect to rebuild at another location. You should also talk to your professional insurance agent to see what coverage options are available
It is important to make sure you purchase adequate limits when you buy your Homeowner’s Insurance. Determining the full replacement cost of your home is an important part of picking the right limit for your insurance. Purchasing replacement cost coverage is highly recommended, so that you will be properly covered for the cost to repair or replace the property should an insured loss occur.
In addition, you will likely want to secure coverage for “additional living expenses.” This coverage generally takes care of your reasonable temporary living expenses during the period of time it takes to repair you home after it is damaged by an insured peril.
Work with your insurance agent to pick the right limit of insurance and valuation options on your property. Your professional insurance agent may also be able to tell you if state law in your state requires an insurer to pay you the policy limit in the event of a total loss.
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Enhanced Insurance is not written by attorneys. If you’re looking for legal advice, you need to contact a lawyer. Further, insurance practices and forms change constantly and are varied from state to state. For definitive answers in your area, contact a local agent.
In a short article such as this, it is not possible to cover all of the items/issues you should be looking at in the purchase of your insurance or the interpretation of your coverage. It is important that you read your insurance policy carefully to see if it meets your needs and covers your exposures. Your policy language may be very different from what is represented here. It is also important that you speak with a professional insurance agent and seek their counsel as respects insurance coverage and your insurance needs.
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