Insurance Q & A: My Bank Wants to Insure Me More Than I Loan?

Insurance Q & A: My Bank Wants to Insure Me More Than I Loan?

Q: “I’ve been talking to my bank about my current homeowners insurance policy. My personal banker informed me that, because I’m refinancing my home for more money ($300,000) than my home is worth ($235,000), I would need to insure beyond my home’s value. Is this a standard practice, or do I have a right to be concerned?”

Katie B.
Cranberry, NJ

* * *

A: Katie, thank you for question. As an insurance advisor, this question comes up far more often than it should. Why? Simply stated, it is against the law for banks to require you to insure more than 100% replacement cost. This legal measure also extends to the insured, whom would profit from being over-insured in the event of a loss.

As a side note: If a mortgage company denies a loan when you are insuring your home for replacement cost and not insuring the home for the loan amount, the mortgage company can be subject to fines and penalties.

While I don’t know the details of your particular situation, banks are risk-based lenders; perhaps an uninformed or unscrupulous agent was involved. As a homeowner, this mistake may have occurred on the banks behalf because of a confusion of terms: market value and replacement cost.

Market value and replacement cost are two different things that influence how much you should be insured for:

• In brief, market value is how much your home is worth, determined by a number of factors (ex. location, crime rate, etc.).
• Replacement cost is the amount that would be needed to restore your home after the event of a loss.

Insurance companies only care about replacement cost.

Besides the illegality, there’s also another reason why having excess insurance doesn’t make much sense:

Suppose you have a brand new $150,000 house that is insured for $200,000. In the event that renders your house completely destroyed, the cost to rebuild the home is $150,000—not $200,000. It isn’t in the best interests of the insurer to assume that type of risk (an excess $50,000), when they could just indemnify your losses or bring your home back to the state it was before the loss.

As a consumer, this excess insurance probably means higher premiums without the coverage. If you had paid $500/year for the higher coverage, you would lose out on $2,500 in a five-year period.

As you can see, it is extremely important to make sure that you are properly insured. If you consult a qualified insurance advisor,  they may help you walk you through a home replacement cost estimator to find the proper amount to be insured. This estimator determines the cost to rebuild your home by taking into consideration some of the following costs:

• Your home’s location (labor & material costs vary with location)
• Age of the home
• Bathrooms (type, finish, and quantity)
• Doors (type, finish, quantity)
• Flooring (type, finish, and quantity)
• Kitchens (type, finish, and quantity)
• Windows (type, finish, quantity)
• The size/square-footage of your home
• The exterior and interior construction of your home
• Exterior structures of the home (ie. pool, deck, gazebo, etc.)
• Amenities (ie. central air conditioning, alarm systems, wine cellar, etc.)

If an appraisal has been completed for your home within in the last 3 years or sooner, there should be a section that shows some replacement costs. If you review the appraisal, you’ll find a few elements that directly relate to how your home’s value was tabulated. Let’s take a look at each in brief:

• cost approach: this is usually the loan amount and not directly related to the home’s value.
• depreciated value: the current value of depreciated materials (this relates to actual cash value) and should not be factored in unless you plan to demolish your house.
• cost of new home: this should be the replacement cost.
  • However, if the notes indicate “Based on various information,” it is better to rely on a replacement cost estimatorevaluation directly from your insurance agent.

* * *

As you can see, there’s a lot to take into account when insuring your home properly AND legally. At RiskBlock, we seek to keep our clients properly insured at the cheapest rates available and putting their worries to rest. Contact us today!