Get all the right insurance when buying a home
When you apply for a mortgage, there are several types of insurance you must buy that will add to your closing costs or your monthly mortgage payments.
There also are optional policies that can help offset other risks to your home.
Here's our best advice on what to expect.
Let's start with the three types of insurance that you will have to buy:
A typical policy covers:
* Damage to your home and other structures on your property.
* Loss of personal property, such as clothing and furniture.
* Liability and medical payments if someone is injured on your property.
* Loss of use if you have to relocate while repairs are made to your home.
* Theft and vandalism to your home.
Because your home is the collateral for your mortgage, your lender will typically require you to have a homeowners policy in effect before closing.
The annual cost will depend on the value of your home and the levels of coverage you choose.
According to the National Association of Insurance Commissioners, you can select the coverage limit for your home, liability and medical payments, while the limits for other coverage are based on a percentage of the home limit you choose: 10% of home limit for other structures, 50% for personal property and 20% for loss of use.
You can choose a higher deductible to lower your premium, but be aware that your out-of-pocket expense will increase by the same amount should you have a claim.
The average cost of homeowners insurance nationwide steadily increased from $593 in 2002 to $822 in 2007 before dropping to $791 in 2008, according to the latest NAIC data. Average expenditures vary widely by state: residents of Texas ($1,460) and Florida ($1,390) paid the highest premiums while Idaho ($387) and Utah ($432) homeowners paid the lowest.
For more information, visit NAIC's Consumer's Guide to Home Insurance.
Private mortgage insurance
If your down payment is less than 20% of the purchase price, your lender will require you to purchase private mortgage insurance, or PMI.
PMI protects the lender from losing money if you default on your loan. It also makes it possible for you to purchase a home with 3% or 5% down instead of waiting for years to accumulate a 20% down payment.
The cost of mortgage insurance is based on a percentage of your loan amount as well as the loan type, term and down payment. As a rule of thumb, expect to pay one-half of 1% of the loan amount, or about $50 to $80 a month for every $100,000 you borrow.
PMI premiums are fully tax-deductible for those who make less than the cap amount, currently $100,000 in income.
Once you've grown the equity in your home to 20% (22% on FHA loans) by paying down your principal, you can cancel your PMI. Appreciation in your home's market value doesn't factor into this equation, only the actual decline in your mortgage balance.
Because your house serves as collateral, you will almost always be required to purchase title insurance. Even if you're not, it can be a good policy to consider, especially in a housing market flooded with short sales and foreclosures.
Title insurance protects both you and your lender against past encumbrances that might imperil your status as owner, including your legal right to transfer title to someone else.
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. Your title insurer would be obligated to defend you in court and pay the settlement if they lose.
Title insurance typically ranges between 0.3% and 0.5% of the purchase price. While your real estate agent will almost certainly have a title insurer to recommend, it's smart to shop around for the best deal.
Insurance you might be required to purchase:
Your homeowners policy pays for water damage caused by bursting pipes inside your house or rain damage from a storm. But if the damaging waters were on the ground before they entered your home, that's a flood and it's not covered by homeowners insurance.
If you live near the ocean or in a federally designated flood plain, your lender will require you to purchase flood insurance prior to closing. But you need not be in a flood plain to purchase flood insurance.
Flood policies are available through private insurers who participate in the federal National Flood Insurance Program. Coverage in moderate- to low-risk areas starts at $129 per year. Flood insurance in high-risk areas can range from $139 for contents only up to $3,000 or more for building and contents.
Optional home-related insurance products include:
Mortgage life insurance
Some lenders or their insurance affiliates might offer you a mortgage life policy, which should not be confused with PMI. This strictly optional life insurance policy pays off your mortgage loan in the event of your death, disability or some incapacitating disease.
While lenders naturally love these policies, they rarely make sense for most families because the survivors might have more pressing needs for the money and it might not make financial sense to pay off the mortgage.
Financial advisers recommend a term life policy instead. It can serve the same purpose at lower cost and give your loved ones the flexibility to use the benefit as they wish.
Realtors often include a one-year home warranty as a housewarming gift for new home buyers. These renewable contracts typically cover the cost to service, repair or replace refrigerators, built-in appliances, heating and air-conditioning systems and plumbing, with an extensive menu of add-ons to cover things like pools and hot tubs.
Are they worth the $300-$500 a year? Opinions vary. If you're buying a home with dated appliances or an antique HVAC system, they could come in handy. If not, the annual fee, plus the $60-$75 you'll pay for each service call, might be better spent toward the purchase of a new appliance.