You probably understand why it’s a good idea to have mortgage insurance (or an independent life insurance policy that will pay off your mortgage in the event of your death), but you might be confused about another type of insurance which banks utilize in the event a borrower lets their homeowners insurance lapse. This insurance is called Forced Placed insurance.
Forced Placed insurance (sometimes also called Lender Placed) is insurance placed on your home that protects the bank’s interest in the event of a catastrophic event such as fire or flood. Forced Placed insurance is NOT a replacement for your homeowners’ policy as it does not cover your equity in the home, contents or provide liability coverage. If you have a mortgage, your mortgage documents require the borrower to maintain adequate insurance to protect the collateral (home) until the loan is paid off. In the event your coverage lapses, the insurance carrier cancels coverage, or you replace the agent/insurance company, the mortgage company must be notified to ensure insurance coverage is protecting the asset.
Why does the bank care whether I have homeowners’ insurance?
If you are like most people your home will be the biggest investment that you make in your lifetime. But the truth is, until your mortgage is paid off, your home is the bank’s investment as well. Your bank makes profit by loaning you the money to purchase your home and then charging you interest.
If you default on the loan, the bank can recover some of its investment by taking back your house and re-selling it.
The problem is, when people have catastrophic events happen to their home and don’t have enough insurance to pay for the restoration, they often can’t afford repairs on their own. In some cases, their homes may even become unlivable.
At this point, many homeowners may be forced to walk away from their mortgage and declare bankruptcy and the bank won’t be able to sell the house unless it invests in extensive repairs.
This is bad for both the bank which has lost its investment, and the homeowner who has now ruined their credit.
Most mortgages require homeowners’ insurance
Think back to when you first signed your mortgage agreement. You probably had to provide proof of your homeowners’ insurance before your loan was approved. It was a condition of the loan. There are all kinds of reasons why a homeowner might lose their insurance. It could be cancelled either by the homeowner or insurance company, or it may even be a simple oversight where the policy is allowed to lapse without being replaced.
Whatever the reason for losing the insurance, it puts the bank and the homeowner at financial risk.
Why is Lender Placed insurance more expensive?
The biggest complaint we hear about this type of insurance is that it costs more in comparison to other homeowners’ insurance. And in fact, it usually does.
The reason for the added cost has to do with risk. If you think about other types of insurance, they always cost more when there is a higher risk to the insurance company. In the case of life insurance, a smoker will pay higher premiums than a non-smoker and in the case of car insurance, someone with a poor driving record will pay more than someone with a good one.
When an insurance company cancels someone’s homeowners’ insurance, it is usually because they deem that policy to be riskier than the average (i.e., that particular home is at greater risk of being damaged by calamity).
Forced Placed insurance is often placed on these higher risk homes. The lender placed insurance companies underwriting the risk are taking the property without evaluating the condition of the property or doing a property inspection. Since these carriers are taking the good and the bad risks, the result is higher premiums due to the higher risk exposure.
The value of protection
You can’t always predict when the next big storm will hit or when faulty wiring from an appliance will spark a flame. If you have adequate coverage however, you can rest assured that you won’t be out of pocket for the damage.
Contact PFI to discuss how to mitigate risk through insurance.