When Your Lender Requires More Insurance Than Your Home Costs to Rebuild

As a homeowner, insurance is a necessity, but how much coverage is needed can be a loaded question.  We all want to get the most value out of our insurance company, but in some instances, you may be asked by your mortgage company to purchase more insurance than necessary to rebuild your home –  leaving you purchasing more coverage than your homeowner’s insurance company would ever pay out in the event of a claim. 

What does California Civil Code section 2955.5 say?

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 some lenders still ask for more

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 to size coverage to reconstruction cost

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 that land value is not insured by a homeowners policy, and it should not be factored into the cost to repair the home. Land is not destroyed by a fire, which is why a reconstruction figure and a market value are different numbers. Title insurance is a separate product covering defects in ownership, not physical damage.

Your insurer does not simply pay the policy limit

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.

Market value and reconstruction cost are not the same

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.

What to do if your lender over-insures you

As you consider your options during the home buying and financing process, work with your insurance agent to determine the proper amounts of coverage. California limits what a lender may require, and the limit is tied to replacement value rather than to the loan amount. An agent can compare the figure your lender is asking for against a replacement cost estimate for the property. 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 section 2955.5.

Statutory provisions change. This reflects the section as written at the time of publication, and the California Legislature publishes the current text.

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.

A lender sets the limit it wants; the policy sets what a rebuild will actually cost. Where those two disagree, the difference is worth documenting rather than absorbing. Ask us for a quote and we will put the numbers side by side.

Disclaimer

This article is provided by Schneiderman Insurance Agency for general informational purposes only. It is not legal, tax, financial, claims, or coverage advice. We are licensed insurance professionals, not attorneys, accountants, or financial advisors, and nothing here should be relied on as a substitute for advice from a qualified professional in those fields. This content is general in nature and is not a review of, or a recommendation for, any individual reader’s specific insurance needs, policies, or circumstances. Insurance coverage depends entirely on the specific terms, conditions, endorsements, exclusions, limits, underwriting eligibility, carrier, and facts of each situation, and the actual policy language always controls. We do not guarantee any coverage, pricing, eligibility, underwriting approval, or claim outcome. Reading this article does not create an agent-client relationship. To understand how these issues apply to your situation, please review your own policy and speak with a licensed insurance professional, and consult legal, tax, or financial advisors where appropriate.