Line up the insurance homeowners need
When you apply for a mortgage, you'll find that there are several types of insurance you must buy that will add to your closing costs and monthly payments. There are also some policies you'll have to decide whether or not to buy.
Here's our best advice on what to expect and what to do.
Let's start with the three types of insurance that you will have to buy:
This provides the money you'll need to:
- Repair or rebuild your home if it's damaged or destroyed by a storm or fire.
- Pay legal and medical bills if someone is injured on your property.
Because your home is the collateral for your mortgage, your lender will insist that you have a homeowners policy that's paid for and in effect when you close on the purchase.
The annual cost will depend on the value of your home and the type of coverage you choose.
But the average cost steadily increased from $593 in 2002 to $822 in 2007. It dropped to $791 in 2008, according to the latest data available from the National Association of Insurance Commissioners.
Expenditures vary widely by state, with Texas ($1,460) and Florida ($1,390) paying the highest average premiums.
For more information, we recommend the Consumers Guide to Home Insurance.
If your down payment is less than 20% of the purchase price, your lender will require you to pay for this.
It protects the lender from losing money if you default on the loan and the sale of your house doesn't fully repay the loan and cover the lender's foreclosure costs.
The payment is charged as a percentage of the loan amount borrowed. It depends on how much money you put down on the home and the type of loan you get. The lower the down payment, the higher the percentage will be.
As a rule of thumb, expect to pay $50 to $80 a month for every $100,000 you borrow.
These premiums are tax-deductible for homeowners who bought or refinanced since 2007 and can meet the income restrictions.
Once your equity in the house has grown to 20% through price appreciation, paying down the principal, or a combination of the two, homeowners have the right to have this insurance discontinued.
FHA loans, however, require that you have 22% of paid equity in your home (price appreciation doesn't count) before you can cancel mortgage insurance.
Because your house serves as collateral, you will almost always be required to have coverage that protects your lender against the possibility that the person who sold you your home was not the full and rightful owner.
Consider the worst-case scenario: Another bank says the previous owner never paid off his or her mortgage and it will now foreclose on you to recoup its money. The title insurer would be expected to step in and pay the bank if it had a legitimate claim to your property.
Coverage typically costs about 0.5% of the purchase price. Your real estate agent will almost certainly have a title insurer to recommend. But you can and should shop around for the lowest cost policy.
You may be required to buy:
Your homeowners policy pays for water damage caused when a pipe bursts inside your house or wind blows off a portion of your roof during a rainstorm. But if the water is on the ground before it enters your home, that's a flood and it's not covered.
You need a special policy for that, and if you live near the ocean or in a federally designated flood plain, your lender will insist that you buy it.
The policies are purchased through private insurers who participate in the federal government's National Flood Insurance Program. They typically cost $300 to $400 a year.
You have the option to purchase:
Life or disability insurance
A life policy pays off your loan if you or your spouse dies. A disability policy will make your mortgage payments if you're sick or injured and cannot work.
Many mortgage lenders offer life and disability policies, but as a general rule, you can do better elsewhere.
The life policies they offer typically cover the amount you initially owed on your mortgage. So while your balance steadily declines, the premiums remain the same.
You'll usually find a term life policy for the amount of your loan to be cheaper and a better deal. If you die, your family will get the full amount of the policy, which is usually more than you still owe on your mortgage.
Again, you should shop around and compare costs.
What policies have you found useful? Which are a waste of money. Tell us in the comments section below.