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A home equity loan lets you borrow against the equity in your home to pay for home improvements, a child's wedding or other major expenses. Because a home equity loan is secured by your home, lenders generally require you to carry homeowners insurance as a condition of the loan. If you're considering a home equity loan, here's what you should know about homeowners insurance.
When Is Homeowners Insurance Required?
There's no law requiring you to have homeowners insurance. However, lenders typically require home insurance before approving any loan that uses your home as collateral. This includes a first mortgage to buy a house and a home equity loan. Homeowners insurance ensures that, even if your home is destroyed, the financial institution doesn't lose its investment.
Once your mortgage is paid off and you own your home outright, you are no longer bound by the mortgage terms and can drop your homeowners insurance. However, if you get a home equity loan on your paid-off house, you're taking out a new mortgage, and the lender will likely require enough home insurance to cover the amount of the loan.
Home insurance requirements for a home equity loan may vary depending on your lender, so it's important to be clear about what is expected of you. Lenders that issue home equity loans are required by law to give you a document called a loan estimate. The "projected payments" section of the loan estimate will list the cost of homeowners insurance (sometimes called hazard insurance) and any other insurance the lender requires you to carry.
Learn more >> Do You Have to Have Homeowners Insurance?
How Much Homeowners Insurance Do I Need?
Standard homeowners insurance typically includes four kinds of coverage.
- Structure or dwelling coverage pays to repair or rebuild your home if it's damaged or destroyed by a covered risk, such as fire, smoke, wind, hail, lightning or vandalism. It also usually protects fences, garages, sheds and other structures on the property. However, it typically doesn't cover damage from floods or earthquakes; you may be required to purchase separate flood or earthquake insurance depending on where you live. Lenders generally insist that you have enough structure coverage to pay off your mortgage loans.
- Liability coverage helps pay medical and legal costs if a visitor is injured on your property. It also covers these costs if one of your family members hurts someone or damages someone else's property off your premises. To protect against a lawsuit taking your assets—including your home—lenders may require enough liability insurance to cover the loan amount.
- Personal property insurance pays to repair or replace your personal belongings, such as furniture and appliances, due to damage from covered risks.
- Additional living expenses (ALE) insurance helps pay any extra costs of living elsewhere during home repairs for a covered loss.
Although lenders don't specifically require personal property and ALE insurance, both types of coverage are built into standard home insurance policies.
Learn more >> How Much Homeowners Insurance Do You Need?
Do Home Equity Loans Require Mortgage Insurance?
If you're currently paying private mortgage insurance (PMI), a home equity loan could mean paying it longer.
Lenders generally require PMI when you make a down payment of less than 20% on a conventional home loan. As you pay down your mortgage, your home equity increases. Under federal law, lenders must remove PMI when you have 22% equity based on your home's original value, or one month after the halfway point of your loan term.
You can also ask to have PMI removed when you reach 20% equity, but you'll need to certify you have no additional liens on the property. A home equity loan (or second mortgage) will generally cause the lender to deny your request. Depending on where you are in your mortgage term, you may want to wait until you hit 20% equity and ask for PMI removal before applying for a home equity loan.
If your home is paid off, a home equity loan is considered a first mortgage, and may require buying PMI again. Check with your lender or review your loan estimate for details.
The Bottom Line
If you've decided a home equity loan makes sense for you, comparing loan offers from several lenders can help you find the best loan terms. Most lenders require a FICO® Score☉ of 680 or more to qualify for a home equity loan.
Before you start loan shopping, check your credit report and credit score to see where you stand. Bringing late accounts current, paying down credit card debt and paying bills on time can all help boost your credit score. Higher scores may help you qualify for lower interest rates and better terms so you get the most from your home equity loan.