Reader question: “I have read that my mortgage lender won’t let me close on my loan unless I have a certain amount of home insurance. Is this true? Do I need to purchase a homeowners insurance policy before closing? And if so, is there a certain amount of coverage that I need to buy?”
In most cases, yes, you will need to purchase a homeowners insurance policy before the lender will allow the closing to proceed. Otherwise, the loan won’t be finalized and funded — and nobody wants that. In a typical scenario, the borrower will bring either the policy itself, or proof of the purchase, to the closing / settlement process. It can also be faxed to the lender and/or escrow company prior to closing.
With that being said, these procedures can vary from state to state, as with the settlement process in general. There is some variation. But generally speaking, borrowers need to buy homeowners insurance before they can close on a home loan. This applies to both purchase and refinance scenarios.
Home Insurance Protects You, as Well as the Lender
When you think about it from the lender’s perspective, it makes a lot of sense. In a typical mortgage scenario, it’s the lender who puts up most of the money for the purchase. The borrower pays much less, in the form of a down payment. So the bank or mortgage company becomes the majority “stakeholder.”
Granted, lenders often sell the loans into the secondary mortgage market (i.e., Walls Street, Freddie Mac and Fannie Mae). But that doesn’t happen right away. And some companies keep a portion of the loans they generate on their books. So the house itself can become a liability for them, if it’s not properly insured. That’s why they typically require borrowers to purchase home insurance before closing day.
According to Wells Fargo: “Homeowners insurance can protect you financially from fires, natural disasters, theft, and other events. It also protects our interest as your mortgage servicer.”
This is why most lenders require proof of coverage before closing. They want to make sure their interests are being protected in the event of fire, earthquake, flooding, etc.
The common practice is that you have to bring a homeowners insurance binder with you to the closing procedures. This binder is provided by the insurer and is proof that you have a policy in place that covers the property. In some cases, a letter from the insurer will suffice, or a photocopy of the coverage document(s).
You can choose which insurance company you want to use. You should shop around for the best policy, just as you shopped around for the best deal on a home loan. The cost of coverage varies based on the amount of protection, the size of the deductible, and other factors.
The company managing your escrow account will likely renew your policy each year. As the homeowner, you will be able to choose your deductible amount. The full amount of coverage is typically decided by the lender, based on their assessment (appraisal) of the home’s value.
So yes, in most cases you will need to purchase a basic home insurance policy before closing day comes around. There may be exceptions to this rule, but I’ve never encountered one.