Purchasing a home involves getting to know a lot of financial terms and processes that most first-time homebuyers have never been exposed to. One of the most confusing is insurance. If you’ve never owned a home before, your familiarity with insurance most likely centers around auto insurance, health insurance, life insurance and, perhaps, renter’s insurance.
Even then, your level of familiarity may be minimal, if you are like most Americans. In fact, a mere 14 percent of those who have health insurance understand even the most basic insurance jargon, such as deductibles, co-payments and co-insurance, according to a study published in the Journal of Health Economics.
The various types of insurance required in the average real estate transaction are even less understood, so let’s take a look at them and get you up to speed.
Title insurance comes in two varieties: a lender’s policy and an owner’s policy. If you take out a mortgage to purchase the home, your lender will require that you purchase a lender’s policy. This protects the lender from anyone else who thinks he is the rightful owner or otherwise has a claim against the property.
Depending on where you live, you may also be required to purchase an owner’s title insurance policy. In other areas, the purchase is voluntary.
The issuance of either policy is based on research of the property’s title, or the “chain of title” as it is known. The examiner will look at public records, such as deeds, wills and trusts to ensure that the wording is proper and that the names on the documents are correct. She will look for outstanding mortgages, judgments and any liens against the property. She will check easements, look for pending legal action against the property and more.
Should the examiner find problems on the title, they will need to be remedied before the purchase can be consummated.
Once the policy is in place, the lender (and you, if you purchase an owner’s policy) is insured against unknown heirs coming forward claiming ownership, forged signatures on the deed, mistakes in the public records, and other hidden hazards.
You may hear homeowners insurance referred to as hazard insurance, but they are one and the same. Again, if you take out a mortgage to purchase the home, the lender will require that you purchase homeowners insurance.
While coverage varies, most policies cover fire damage or loss, theft, wind damage, hail damage, vandalism and more. Some perils aren’t typically covered, such as flood and earthquake damage, but there may be supplemental insurance that you can purchase to cover these hazards.
Your insurance agent can help you determine how much coverage you require, based on the loan amount and what it might cost to rebuild the home.
Payments to the insurance company are either kept in an escrow account sent in with your mortgage payment or the homeowner pays the premium on her own – it varies by insurer.
If you suffer a loss, the insurance company will typically make out the check to both yourself and the lender.
Private Mortgage Insurance
Private mortgage insurance is something most homebuyers and homeowners would love to get rid of, but it’s a necessary evil. Without it, many buyers would not be given a mortgage and thus not be able to purchase a home.
PMI is required of borrowers whose down payment is less than 20 percent. Because these borrowers are considered higher risk, the lender needs assurance that it will get its money should the borrower default on the loan.
Because the borrower pays the premium (typically added to the monthly mortgage payment), it seems that the lender is the only party that benefits. Keep in mind, however, that without PMI, lenders would demand a 20 percent down payment. Therefore, the cash-poor borrower reaps an enormous benefit.
The good news about PMI – at least for those with conventional loans – is that you can request a cancellation of the insurance once your loan balance reaches 80 percent of the original value of the home. Unfortunately, borrowers with an FHA-backed loan are locked into paying mortgage insurance premiums for the life of the loan, if they put less than 10 percent down. Borrowers who pay more than 10 percent, but less than 20 percent, can cancel the mortgage insurance in 11 years.
The best people to speak with if you have questions about any type of insurance required during the home-purchase process are your lawyer, your real estate agent and your insurance agent.