Q: We are in the process of buying our first house, and have become confused with the various types of insurance we have to buy. Can you explain these insurance items and do we need any or all of them?
A: You are not alone in your confusion. Homebuying is too compartmentalized, and the consumer rarely gets a full and complete picture - in advance - of the entire process.
Let's look at the insurance policies available for the homebuyer. Some of these will be required and some are optional.
Hazard insurance: This is also referred to as "homeowner's insurance." Your mortgage lender will require that you obtain a policy covering at least the amount of the loan. A lender's only real security is your house. In the event it burns down, or is otherwise destroyed, the lender needs the additional security of an insurance policy.
But you need not purchase hazard insurance from your mortgage lender. You have the legal right to carry property insurance with the company of your choice. Shop around and ask for a full explanation of coverage and rates.
Don't forget to include an automatic escalator clause in your policy. Houses in this area are increasing in value every year, and your insurance coverage should be similarly increased.
Mortgage insurance: This protects the security of the loan. If you are able to make a large downpayment (usually 20 percent of the purchase price) there should be no need for this type of mortgage insurance. In the unlikely event that you default in your mortgage payments, your house will be sold at a foreclosure sale and should bring in enough proceeds to pay off the mortgage.
But if you obtain a "no-money down" loan, or only put up 5 or 10 per cent of the purchase price, your mortgage lender may not be fully compensated in the event of foreclosure. Thus, mortgage insurance protects the lender by insuring a portion of the loan. The buyer will pay a fee for this insurance coverage.
Under governmental programs, the Veteran's Adminstration and the Federal Housing Administration will guarantee the lender against this risk. Additionally, there are many private mortgage insurance companies which perform the same function. You don't have to shop around for private mortgage insurance like you do other types of insurance. Your lender will provide the coverage, and thus when you shop and compare for lenders, make inquiries as to the cost of this insurance.
And if you do use private mortgage insurance, ask the lender in advance how long you will be required to keep paying the premium. Don't forget that this type of insurance covers the top portion of your mortgage. In time, with the increased equity in your home there should be no further need for the policy.
Title insurance: Once you have obtained your loan, you are ready for the title search and settlement. Lawyers and title companies will search the land records to determine whether there are any defects (clouds) in the title. But, some matters can create clouds without being on the public records - such as forged signatures, errors of recording officials or undisclosed heirs.
Your lender will insist that you purchase "lender's title insurance." This is a one-time charge, collected at settlement. You also have the right to obtain an "owner's policy" at settlement that covers your investment in the home over and above the mortgage. Insist on a full explanation as to what the owner's policy covers (and what it does not cover).Is there a market value coverage or is the policy limited to the current purchase price? And, is there a reissue rate available to you, based on your seller's previous policy?
Too many title attorneys and companies try to sell the owner's policy without giving you a choice. Owner's coverage is optional - and only you can make the decision.
Mortgage life insurance: Now what you settled into your new home, you may be deluged with solicitations to purchase mortgage life insurance. In the event you die, the policy will pay off the balance of your mortgage.
I don't recommend this type of policy at all. Generally speaking, if you want insurance, you can get a better deal by purchasing additional life insurance - whether term or straight life.
Don't forget: With a mortgage life insurance policy, you pay the same premium even though the coverage is decreasing. Every year your mortgage goes down a little. It pays to increase - not decrease your insurance coverage.