Why are my mortgage and insurance companies insisting I have replacement cost in my mortgage insurance?

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They say I need $ 160K insurance for a $ 76K loan. Appraisal on the house is about 85K. I have been bouncing back and forth on the phone and no one can give me a straight answer as to WHY they require replacement cost. Please help me understand why the mort co instsis I get a new free house if there is a fire.

  1. Reply
    May 18, 2011 at 11:25 am

    you are misunderstanding them sir. If the home appraises for 85K that is all any insurance company will insure it for. But if you misstated the appraised amount and it is actual $ 185k then they need that much to rebuild the home in case of fire or storm that completely destroys the home. The ground under the home or the land is not insured since it will remain. Just because the loan is only for 76k doesn’t say if you default on the loan and the fire happens in that time they are not getting good value for what they loaned on. So if you miss stated the appraised $ $ then why would you want to be under insured

  2. Reply
    May 18, 2011 at 11:53 am

    To protect their interest in the property- they want assurance that the house can be rebuilt to today’s standards should it be destroyed. The loan balance does not dictate the insurance coverage required.

  3. Reply
    John Harris
    May 18, 2011 at 12:26 pm

    Because if you bought your house for $ 100,000 twenty years ago and its now worth $ 250,000, you only get $ 100,000 if it burns down without you having replacement cost insurance. With replacement cost insurance you get $ 250,000 since they pay you what it will cost to replace.

  4. Reply
    May 18, 2011 at 1:15 pm

    Because, most homeowners policies are based on cost to rebuild the house. Because of that, if that’s the kind of policy you have, and there is a partial loss, and you aren’t insured to the full repalcement, then you don’t get the full payment for the loss.

    Sounds confusing. But let me explain with real numbers. We probably both agree, that most losses are partial losses. We also probably both agree, that you couldn’t rebuild your house, if it burnt to the ground, for $ 76K, even if it’s only worth, market value, $ 85K. Lastly, if you think about it, we probably both agree, that if your kitchen is 20% of the square footage of your house, and your house is worth $ 85K, and you have a kitchen fire, your insurance company can’t just pay you for the kitchen part of the house (20% of $ 85K, or $ 17K) and walk away. You’re going to want them to pay to FIX the kitchen.

    OK, so the standard policy has a “coinsurance” clause in it. For math’s sake, let’s say that it is 100% (although some will be 90%). What that means is, if you underinsure the house, they only pay the portion of the claim that you insured. So, your house is worth $ 80K. Your mortgage is $ 76K. The cost to rebuild is $ 160K. You decide you want to insure the house for the $ 80K, what it would bring if you sold it.

    You have a kitchen fire. There’s water damage to the living room and bathroom downstairs, smoke damage throughout the house, and you need a brand new kitchen. Estimate of the damages, $ 60,000. Under your policy limit of $ 80K, right? Right. BUT. You only insured the house for half the value. They pay half the claim, $ 30,000. Minus your deductible.

    Now, you have to either cough up $ 25,000 to fix the kitchen, or you have a house you can’t use the kitchen in . . . and likely one that won’t sell for half of your payoff. Most likely, you’d abandon it, and leave the bank with a house that they can only sell at a major loss, leaving them holding the bag on the loan balance.

    And that’s why lenders want you to insure for full replacement value.

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