Why Do Lenders Require Homeowners Insurance?

There aren’t many people who choose to buy their home with cash. After all, it takes years to save money for a nest egg, and paying off the entire property in one swoop might seem completely out of reach. Still, if you choose to finance your home with a mortgage, you can afford the home you want and pay it off over time.

However, if you do take out a mortgage, then your lender will likely require you to buy homeowners insurance. Why does this rule exist? Why is it something you have to follow?

Why You Have Coverage Requirements

When you take out a mortgage on your home, you receive a loan from the bank to make the purchase from the seller. However, you agree to pay that loan amount back to the bank over the years. The money doesn’t belong to you, and is instead the banks. They will have a long-term investment in your home for as long as you have the mortgage.

Because of this relationship, most lenders require homeowner's insurance. If there were to be something that came along and severely damaged the home, then both parties could lose out on the deal. The damage will cost money to repair, and in a worst-case scenario you might even face the total loss of your home. That is a threat to both you and the lender, and as a result, both parties can benefit from the assistance provided by homeowners' insurance.

In many cases, mortgage lenders are required by law to secure these investments by requiring the homeowner to buy home insurance. They won’t have reason to ever lose money on the investment. However, this requirement is equally important for the homeowner, too. If you can let your home insurance pay for repairs, then you won’t have to choose between meeting your mortgage and repairing your damage. Therefore, your overall financial security will remain intact.

Getting the Right Homeowners Insurance

When your bank tells you that you need to buy homeowners insurance, they will likely set a few minimum standards on what coverage you need. To cover their investment, they will usually require dwelling insurance that equals the replacement cost value of your home. This is an amount of money that reflects how much you would have to spend following the total destruction of your home.

Furthermore, if you have other structures on your property, then your lender might also mandate that you buy detached structures coverage, which is part of most standard insurance plans. Some lenders require additional coverage, such as liability insurance and possessions coverage.

It’s important to work with your insurance agent to determine which coverage will help you maximize the assistance you can receive from your plan in case of a claim. At times, this might even exceed the coverage required by the lender.