Property Appraisals Can Affect Homeowners Coverage Required by Refinance Lenders

March 30th, 2010

You have owned your home for several years and have completed a loan application for a refinance. Your loan officer calls and says you must increase your homeowners insurance policy by 25%. Why?

You have had the same mortgage and the same insurance policy for several years, and because you have a loan application in process to get a lower mortgage rate and monthly payment, you have to increase your insurance premium? It doesn’t make sense, but that is what has been happening across the country.

Minimum Coverage

For every refinance mortgage or purchase mortgage funded, mortgage lenders want to ensure they are insured against loss of value from fire or other potential disaster. As part of the approval and closing process for your loan application, you must provide an insurance policy that covers replacement of the dwelling or repair should it sustain damage. The insurance must either cover the amount of the loan or completely rebuilding the structure(s) if completely lost. If your loan amount is $100,000 and the cost to replace your home is $135,000, then the lender will require a minimum coverage of $100,000–if your house is a complete loss you have coverage to pay off the mortgage. If the mortgage amount is $235,000 and your replacement value is $175,000, then your policy must cover at least rebuilding the property for $175,000.

Insurance Company Valuation

When providing the policy, your insurance agent most likely will use a software program to determine the cost to rebuild your home should it be damaged or destroyed under covered events–say, a fire. The replacement cost calculation includes all materials, labor, permits, and other costs if the company were to rebuild your existing home. This valuation does not take into account the value of the land (since dirt doesn’t burn you don’t insure it against a fire). Based on this software valuation, your agent will provide you with a premium.

As part of the property appraisal, the appraiser will complete a section detailing the costs to replace the structure(s) should there be a total loss. The calculation considers the cost to replace new and also depreciates this value to support the current value of the property. Most appraisers use third-party software–one of the most popular being from a company called Marshall and Swift–that calculates the replacement value based on region of the country, size of the property, and construction materials.

In the past several months, in areas of the country where the land value likely exceeds the replacement value of the structures (areas such as coastal California, Chicago, New York, and parts of Florida and Texas), there has been a large discrepancy between the replacement value calculations of the insurance agent and the property appraisal. When there is a discrepancy, the lender will use whichever calculation provides the highest amount of coverage; even though the insurance company is guaranteeing the replacement of the structure base upon their calculations, if the property appraisal shows a higher replacement value, that higher value is what will be required for the policy to close the refinance mortgage or purchase mortgage application.

For example, let’s say you have submitted a loan application for a refinance mortgage of $250,000. You have an existing insurance policy that covers replacement costs of the property for $175,000, and your policy premium is based on that. Your property appraisal comes back with a valuation of $400,000, more than enough for your loan application approval. In the property appraisal, the replacement value calculation says the cost to replace your home is $235,000, or 35% higher than what your existing insurance policy covers.

In order to close the refinance mortgage transaction, you will have to obtain coverage for the $235,000 replacement costs. This means your insurance premium will go up accordingly, decreasing the benefit you will receive from lowering your mortgage rate.

During your loan application process for a refinance, check with your loan officer to see if the lender will allow you to maintain your existing homeowners policy or if you will be required to raise the coverage if the property appraisal shows a higher replacement value for your home.

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1 Responses to "Property Appraisals Can Affect Homeowners Coverage Required by Refinance Lenders"
  1. dewaine 31, Jul, 2012

    If anyone related to this article reads this, what is the CA statute that supports the minimum coverage paragraph, specifically that a mortgage company may not require $235K in dwelling coverage to cover the loan when all the insurance company will pay is the true cost of the dwelling replacement, $175K? PLEASE email me the answer. Thank you.

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