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Hazard Insurance

by Michael Main

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People often wonder why their lenders require them to have hazard insurance on their property. The answer to this question is simple, if a property is damaged for some reason, insurance provides the means to restore it to its original condition. This is an obvious statement, but important to both the borrower and lender. No one desires to continue making mortgage payments on a property that has been damaged or destroyed, and no lender wants to foreclose on a property that has lost its value due to being damaged.

This is especially true with regards to asset based lending. In asset based lending, such as we do here at Larry the Lender, the only protection against loss on a loan is the property itself. By not linking the loan to a borrower’s credit score or bank account, it is only the value of the property itself that determines the loan amount, and provides protection against loss. When a property has structures on it, it becomes imperative that the structures are insured against loss. This is where hazard insurance comes in.

Hazard insurance does not cover every type of loss however. The Texas Department of Insurance provides a table describing the items generally included or excluded in a hazard insurance policy. The table blow can be found on the TDI website.

Most Policies Cover Losses Caused by Most Policies Do Not Cover Losses Caused by
Fire and lightning Flooding
Sudden and accidental damage by smoke Earthquakes
Explosion Termites, insects, rats, or mice
Theft Freezing pipes while your house is unoccupied (unless you turned off the water or heated the building)
Vandalism and malicious mischief Losses if your house is vacant for the number of days specified by your policy
Riot and civil commotion Wear and tear or maintenance
Aircraft and vehicles Wind or hail damage to trees and shrubs
Windstorm, hurricane, and hail (this coverage may be excluded if you live on the Gulf Coast) Mold, except what is necessary to repair or replace property damage caused by a covered water loss
Sudden and accidental water damage Water damage resulting from continuous and repeated seepage

There are two things that here in Texas a property owner needs to be especially aware of. First, is that flooding is not covered in standard hazard insurance policies. Second, is that termite damage is not generally covered by hazard insurance policies. This means it is possible a lender may require additional property coverage for those potential losses. Most common in the Gulf Coast area is a requirement for flood insurance. Properties located in a flood zone will almost always be required to carry this type of coverage. Maps of these flood zones can be obtained from the Federal Emergency Management Agency (FEMA), such as the maps of Harris County, Texas, located on their website.

The amount of coverage that should be carried is up to the owner and their lender. Lenders will generally require enough coverage to rebuild the property, at a minimum. There are two primary ways they come to a figure for this. First, is the coverage should be at least as much as the loan amount. This is a figure that will often be accepted by lenders as enough to cover any loss. The second method for determining the minimum coverage, is what’s called the replacement value of the structure. This comes from either an appraisal on the property, where the appraiser will put the total cost to rebuild, or will be determined by the insurance company themselves, based on their own data.

The cost of insurance, at least in Texas, varies widely depending on the insurance company providing the coverage. In general, an annual premium somewhere in the range of 0.5% to 1.0% of the replacement cost is common. Estimating the cost to be around 0.75% of the replacement cost would probably not be far wrong. Ultimately, an insurance company will need to be contacted in order to receive an insurance quote. Like any other major purchase, it is best to get offers from more than one provider before making a decision on which coverage to purchase.

Purchasing property has many costs. Included in these is the cost of insurance coverage. While insurance is not cheap, it is well worth the costs, protecting everyone against loss by damage to the property. There can be no better reason for its purchase than that.