Any asset that is financed typically requires insurance or some sort of pledge to repay, even if the asset is somehow lost or destroyed. A bank won’t make a loan for a new car unless there is insurance coverage ready at the helm. So too mortgage lenders require there be insurance on the home that takes effect the moment the closing papers are signed and the buyers officially own the house.
At the settlement table, there will be one year’s policy paid upfront and an escrow or impound account set up to contribute 1/12th of the annual insurance premium to be paid upon renewal. But there are certain requirements for insurance when financing a home using a USDA loan.
The USDA lender will require a minimum amount of coverage. This amount is either the loan amount or the estimated cost to replace the structure entirely. That’s the minimum. The estimated cost to replace will be found in the property appraisal report. The appraiser will make two values, one is the current market value based upon recent, similar sales of homes in the area and the other is how much it would cost to replace the home built from the ground up. It does not include the value of the lot.
In addition, if there are any extra upgrades considered to be above the norm, such as higher end appliances or countertops, you’ll need to add this coverage to your policy. The policy amount being at least the amount of the mortgage is the amount the lender would be paid in the event of a catastrophe and might not include upgrades such as wood floors. Your insurance agent can help guide you through the process just remember the policy amount required by the lender is the minimum amount allowed. Anything lower than that and the USDA lender won’t issue the loan.
A standard insurance policy will protect against fire, wind and hail but does not cover additional hazards without an additional rider which covers such hazards. Standard insurance policies do not cover earthquakes or floods.
Flood insurance will be a requirement however if the property is located in an area deemed a flood zone by FEMA. One of the very first things USDA lenders do upon receipt of a completed USDA application is to order what is called a Flood Certificate. This tells almost immediately if the property is located in a flood zone. If the certificate does indicate a flood zone, another service needs to be ordered, an elevation report.
The elevation report will provide a certificate indicating the location of the flood plain and whether or not the structure itself is located within this zone. If it is, flood insurance must be purchased and is much more expensive than a standard policy. So much so that buyers tend to back out of the sale when they see how much their insurance premiums rise. So too in coastal areas a special policy can be required for high winds or hurricanes.
The insurance policy will clearly name the payee, which is the mortgage company. If a structure burns down for instance the borrowers don’t get the money to be forwarded to the lender, the insurance company pays the lender directly.
Should the policy ever lapse or get cancelled for any reason, the lender is notified and if no new insurance policy is provided, the lender will “force place” a policy. Such policies are extremely expensive. However, with a USDA loan, this rarely if ever happens because the monthly insurance premiums are included in the monthly payment and can only happen during the case of a default.
USDA lenders require not only a minimum policy amount but they may have different limits on the deductible on the policy. The deductible is the amount you must pay on your own along with the amount the insurance company will pay. If the claim is $10,000 and your deductible is $1,000, the insurance company will pay $9,000. The higher the deductible, the lower your annual premium. Some lenders however limit the deductible amount to 1% to 2% of the claim.