When you close on a home, your mortgage lender will require you to carry sufficient home insurance to protect it. Find out which coverages you need by consulting our guide.
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If you’ve just found the house of your dreams and gone through the tedious, often-stressful process of securing homeownership, the last thing you want to do is handle more paperwork. However, finding home insurance is just another part of being a dutiful homeowner, and it will benefit you in the long run to understand your coverage, how it all works, and how much you need.
You’ll need to follow the lender’s stipulations on how much coverage is required if you’ve just taken out a mortgage for your new investment. In our guide to mortgage lender requirements for homeowners insurance, we’ll review the coverages you need and demystify other insurance terms you may have come across on your homebuying journey.
Your mortgage lender has a financial stake in your home for as long as you’re making payments. Having homeowners insurance provides financial protection for both you and the lender in case of a loss. If a catastrophic event damages your home and you don’t have home insurance, you and your mortgage lender would be on the hook for an expense that could have been covered by a homeowners policy. Lenders require home insurance to protect the investment they’ve made so that they won’t lose money if something happens to your home.
Home insurance requirements set by mortgage lenders depend on a few factors: how much you paid as down payment, the amount of your loan, and if the location of your home calls for additional coverage. Here are the three key points to consider before purchasing an insurance policy for a new home.
Lenders will likely require that you carry enough insurance to cover the amount of your loan. For instance, if you bought your home for $300,000 with a $60,000 down payment, your lender will want you to have at least $240,000 worth of dwelling coverage. However, we always recommend insuring your home for its full replacement cost to ensure it could be replaced in the event it’s ever destroyed.
Let’s review some of the coverages your mortgage company could require for your homeowners insurance policy.
Coverage for the dwelling is the cornerstone of any homeowners policy and is the only required coverage your mortgage lender will mandate that you have. Dwelling coverage makes up a large portion of your policy and covers the main structure of your home, including any attached structures. The lender can also stipulate that claims payouts will be calculated based on replacement value versus an actual cash value basis. Replacement cost dwelling policies tend to be a bit pricier but guarantee that you can rebuild what you lost. Policies based on actual cash value would only pay out what your home was worth at the time of loss — deducting for depreciation.
If you live in an area vulnerable to hurricanes, windstorms, and other natural disasters, the mortgage lender can require that you carry windstorm coverage. Keep in mind that some states impose separate hurricane deductibles for storm events, usually calculated as a percentage of your dwelling limit (1% to 10%).
Hurricane coverage only covers damage sustained from strong winds and hail. Flooding, a common occurrence with hurricanes, is not covered by a typical homeowners policy. Your lender could require that you purchase flood insurance if you live in a flood-prone location. Flood coverage is generally provided by the National Flood Insurance Program (NFIP) but there is a number of private insurance options as well.
Like flood insurance, earthquake insurance could be mandated by your lender if you live in a vulnerable area and can be bought as a separate policy or an endorsement depending on your insurance provider. Earthquake coverage can be purchased from state-run programs — like the California Earthquake Authority — or from some private insurance companies.
This is a less-common occurrence, but depending on the location of your home, your mortgage loan provider may require you to carry additional coverage through endorsements. For instance, water backup coverage would protect your home against water damage from broken sump pumps and overflowing water from sewer pipes.
If you’ve ever insured a financed or leased vehicle, you may remember putting down your auto lender as an additional interest on your policy. This is the homeowners equivalent — but this time, your mortgage lender will be the one to require you to list them on your home insurance policy as a loss payee. Doing this makes certain that if you ever need to file a claim, they would also be entitled to a payout in the event of a covered loss.
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Unlike home insurance, mortgage insurance (often known as PMI, or private mortgage insurance) benefits only the mortgage lender and in no way does it cover the homeowner and their property. While this is something the homeowner pays for if they do not meet the threshold down payment, it only benefits and protects their lender in case the homeowner ceases mortgage payments. PMI generally costs between 0.5% and 1% of the loan amount — which sounds low — but can quickly add up depending on how much funds you took out for a mortgage.
Like mortgage insurance, hazard insurance is usually required by your lender when you buy a home. But unlike PMI, hazard insurance is not a separate insurance policy — to put it simply, it refers to the part of your homeowners policy that protects the structure of your home from certain perils like fire, lightning, and wind — in other words, your dwelling coverage. Because of the financial capital the lender has tied up in your new home, it is in their interest to safeguard the property against potential damage or destruction.
As discussed previously, coverage for the dwelling and structure of your home is a standard part of any homeowners policy. If you have home insurance, you've already fulfilled your lender's requirement of having hazard insurance.
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