Insuring the Property

Elementary Insurance Primer

While you are in the process of getting your paperwork together, your attorney will notify you that you need to have your future home insured. While this is a very smart idea, it isn't your choice. Your lender will require homeowner's insurance on the property with coverage equal to at least the amount of the loan they will be giving you. The lender is looking to protect its investment in your property in the event of a total loss.

How much coverage do you need?

Is insuring the property up to the minimum required by the bank enough?

Before we answer those questions, we have to talk a little bit about something called co-insurance, also sometimes referred to as the "80% rule."

Coinsurance

Before you will be reimbursed the full cost of a partial loss resulting from any insured event, you must purchase coverage for at least 80% of the current replacement value of the property. If not, your reimbursement will only be the percentage that your coverage bears to 80% of the replacement value. Let's look at an example:

Let's assume the following facts:

Your mortgage

$ 120,000

Current replacement value
of your home

$300,000

Your lender will require you to insure the property for at least $120,000, which is the amount of their loan to you. Let's say you do that. Three months later you have a kitchen fire that costs you $10,000 to repair. You figure that since you're insured for $120,000 and $10,000 is certainly far less than that, your entire bill will be covered by the insurance company. Think again.

Since your coverage of $120,000 is only 40% of the replacement value of the home ($300,000), you have not met the coinsurance clause requiring 80% coverage. This means that of the $10,000 bill, the insurance company will only cover 50% ($120,000/$240,000). 50% of $10,000 is only $5,000, leaving you stuck with a bill for $5,000 to pay out of your own pocket. That's a mighty rude surprise when you thought you had sufficient coverage because that's what you thought was needed.

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