Excessive Homeowners Insurance Requirements

Some lenders will delay the homeowners’ closing date unless the borrower buys an amount of insurance equal to the mortgage.  If that amount is excessive, it can cause some stress during the lending process.  The California Civil Code Section 2955.5  specifically addresses this situation to provide some clarity for homeowners. It states:

2955.5. (a) No lender shall require a borrower, as a condition of receiving or maintaining a loan secured by real property, to provide hazard insurance coverage against risks to the improvements on that real property in an amount exceeding the replacement value of the improvements on the property.

(b) A lender shall disclose to a borrower, in writing, the contents of subdivision (a), as soon as practicable, but before execution of any note or security documents.

(c) Any person harmed by a violation of this section shall be entitled to obtain injunctive relief and may recover damages and reasonable attorney’s fees and costs.

(d) A violation of this section does not affect the validity of the loan, note secured by a deed of trust, mortgage, or deed of trust.

(e) For purposes of this section:

(1) “Hazard insurance coverage” means insurance against losses caused by perils which are commonly covered in policies described as a “Homeowner’s Policy,” “General Property Form,” “Guaranteed Replacement Cost Insurance,” “Special Building Form,” “Standard Fire,” “Standard Fire with Extended Coverage,” “Standard Fire with Special Form Endorsement,” or comparable insurance coverage to protect the real property against loss or damage from fire and other perils covered within the scope of a standard extended coverage endorsement.

(2) “Improvements” means buildings or structures attached to the real property.

Why do some lenders not adhere to this when you are a homeowner and seeking a loan in the state of California? Let’s not forget that many lenders have offices throughout the country and their staff is not well versed in each state’s rules and regulations.  Additionally, many areas of California provide for a unique home valuation where the real estate in areas near the coast or in highly affluent areas may have a higher value than the actual house itself.

How can you be sure you are adequately insuring your home, but not excessively insuring it at the same time? Insurance companies typically use cost estimation software which takes into consideration the square footage, construction materials, as well as quality of the home and its architecture along with considering reasonable costs in a specific area for labor and materials.  Furthermore, most loans require an appraisal where a trained professional on home valuations provides the separation for land value and reconstruction costs.  Comparing the appraiser’s reconstruction valuation and a construction cost estimation from your insurance carrier can provide a much more reasonable and analytical approach compared to purely using the amount of the loan as a basis.  Remember, the land value is not insured by your homeowner’s insurance, the land is protected by title insurance and should not be factored into the cost to repair your home.

Wouldn’t the Homeowners Insurance Company just pay based on the limit on the policy?  Insurance companies that write homeowner’s insurance are not required to pay based on the limit of insurance that you purchased after a homeowners insurance claim.  The insurance company is typically going to pay based on the lesser of:

• The limit of insurance on the policy that covers the lost structure
• The cost of replacing the damaged portion of the building with materials of similar kind and quality and for similar use
• The actual necessary expenses to repair or replace the damaged structure.

As you make decisions related to the amount of homeowner’s insurance you need, it is always important to know that there is a difference between the Market Value and the amount to reconstruct your home.  The market value of your home includes land and improvements taking into consideration how much someone would pay for a similar property.  The Reconstruction Cost of your home is based on the cost of labor and materials to build a home with similar features and construction materials.  Your homeowner’s insurance is designed to replace your home through reconstruction or replacement, not to provide the Market Value of your home as you would still have the land even if the home was completely destroyed.

As you consider your options during the home buying and financing process, work with your insurance agent to determine the proper amounts of coverage. While the state of California has laws to protect homeowners from excessive lender insurance requirements, you should consult your local insurance agent to make yourself aware of the protections afforded to you in your state. If you are in California, and your lender requires a home to be insured for more that its replacement cost, show the mortgage company a copy of California Civil Code 2955.5 which can be found at www.leginfo.ca.gov/calaw.html.

This article is not to be construed as nor is this legal advice or legal interpretation of each state’s general statute. Consult with counsel to assure compliance with individual state statutes.