Understanding the Difference Between Loan Amount and Insurance Rebuilding Cost for Your Home
Are you paying too much on your insurance policy?
Did your mortgage lender told you your rebuilding cost needed to match your loan amount? That’s actually not true and today we’re going to discuss the difference between the two.
Let’s talk about mortgage and insurance today…
Trailstone helps a lot of people with insurance when they are purchasing a home, and this question comes up frequently: What is the difference between the mortgage loan amount and the rebuilding cost in insurance coverage? And a follow-up question is… if a home were to be a total loss from something like a fire, would the insurance pay off the mortgage balance? Let’s tackle the first question about the mortgage loan value and insurance rebuilding cost.
Mortgage Loan Value vs. Insurance Rebuilding Cost
First, your mortgage loan value is the amount you are receiving from the lender. The loan value is a net calculation of the sales price, down payment, seller concessions, and fees for the loan. To make this simple, think of it this way: you purchase a home for $500,000 and you put $100,000 down. This leaves a loan value of $400,000 before fees or concessions. In this example, let’s use $400,000 for your loan value.
Now, let’s talk about how the insurance rebuilding cost is calculated. Insurance companies are required to use a cost estimator software program to determine the rebuilding cost of your home. These software programs are updated every 6 months with current building material and labor costs in order to get an accurate dwelling coverage amount. I’ve got another video that dives deeper into rebuilding costs and why it’s so accurate. Check the link in the description if you’re interested.
Your home information is entered into the cost estimator system. The data used to calculate your home rebuilding cost includes location, square footage, architectural design, quality of finishes, and type of materials used, among other data points.
Factors Excluded from Rebuilding Cost
Something to keep in mind: there are several things that are not included in the rebuilding calculation, and this is important to understand in relation to the retail sales price of your home.
First is land, meaning your lot or acreage.
Second is landscaping, including your trees, lawn, and shrubs.
Lastly, intangibles such as a desirable location—think of this as vacation spots or a home in desirable school districts.
So remember, these items are not included in your rebuilding cost.
Example Scenario: Loan Value vs. Rebuilding Cost
Many times, your rebuilding cost will be less than the retail value of your home, and this is okay based on the variables we just talked about. But the important thing to remember here is that the insurance rebuilding cost is just that—the cost to rebuild your home. Also, we discuss dwelling extension coverage in the video “What in the heck is a dwelling extension endorsement?” The dwelling extension endorsement can add 25% additional coverage at a minimum and many times all the way up to unlimited dwelling extension.
Going back to our example from earlier, the home retail value is $500,000, the loan value is $400,000, and we will use $300,000 for the insurance rebuilding cost.
So, not considering the dwelling extension endorsement, this home appears to be underinsured by $100,000 from the insurance rebuilding cost compared to the loan value.
Why Mortgage Lenders Care About Rebuilding Costs
In this case, many times, the mortgage underwriter will request the rebuilding cost to match the loan value or to have a dwelling extension endorsement that will increase coverage above the loan value. This is because the lender wants the insurance rebuilding cost to cover the loan in case there is an insurance claim on the home. Makes sense, right? Everyone is happy, the loan closes on time, and you move into your new home.
Everything is great, right? Well, maybe, maybe not.
But what happens if the home were to suffer a total loss shortly after you move in? Will your mortgage loan be paid off by the insurance company? Well, maybe, maybe not.
Handling Total Loss Scenarios
What do you mean my loan may not be paid off?
Well, the insurance company agreed to rebuild your home for $300,000 and did not agree to pay off your mortgage loan of $400,000. But you say… what about the dwelling extension? I have unlimited rebuilding cost. Unfortunately, this is for rebuilding the home and not paying off the mortgage.
So how does this all get worked out?
Generally, the insurance company would pay $300,000 to the mortgage lender, leaving a $100,000 shortfall. This shortfall would need to be rolled into a new construction loan to rebuild the new home.
It is important to understand all of these issues when you are purchasing a new home or refinancing your current home.
Preventing Mortgage Shortfalls
Also, there are some insurance coverages to prevent this mortgage shortfall from happening. Not all insurance companies offer the coverage, but many of our 40 insurance carriers do.
Our team of insurance specialists here at Trailstone Insurance Group have the “Heart of a Teacher,” meaning we will teach you about your insurance, not just sell you a policy. If you would like to learn more about how to protect your home properly, reach out to us. Give us a call, send us an email, or use the link below to get your quote going.
FAQs
Why does my mortgage lender want the rebuilding cost to match the loan amount?
Mortgage lenders require the rebuilding cost to match the loan amount to ensure they can recover their investment in case of a total loss. This helps protect the lender’s financial interests.
Will my insurance policy pay off my mortgage in the event of a total loss?
Insurance policies are designed to cover the rebuilding cost of your home, not necessarily to pay off the mortgage. Any shortfall between the insurance payout and the mortgage balance would typically need to be covered through a new construction loan.
What factors are excluded from the insurance rebuilding cost?
The insurance rebuilding cost typically excludes the land value, landscaping, and intangibles such as the desirability of the location.
How can I ensure my home is adequately covered?
Work with an independent insurance agent like Trailstone Insurance Group to review your coverage options. We can help you find policies with appropriate rebuilding costs and dwelling extension endorsements to ensure comprehensive coverage.
What is a dwelling extension endorsement?
A dwelling extension endorsement provides additional coverage beyond the standard rebuilding cost. It can add 25% additional coverage or more, sometimes up to unlimited dwelling extension, to ensure your home is fully covered.
Can Trailstone Insurance Group help me with my insurance needs?
Yes, Trailstone Insurance Group works with over 40 insurance companies to find the best coverage and pricing for your needs. Our team is dedicated to teaching you about your insurance options and ensuring you have the right coverage.