Real Estate Insurance 101: How to Best Protect Your Investments
In a recent BiggerPockets article, “Used Wisely, Debt Can Absolutely Produce Wealth: Here’s How,” I discussed the efficient, productive use of debt to build wealth, but I also referenced the fact that I don't worry about utilizing leverage to expand my portfolio of both real estate and notes, largely due to the fact that I'm a strong proponent of insuring all of my investments.
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The question that kept coming up was what insurances I use and how I use them to protect my real estate, and so, as promised, I would like to further discuss this topic.
First of all, I didn’t always think about insurance and investing the way I do today. I used to think that insurance was a necessary evil. It was something I wanted to spend as little money as possible on.
I'll never forget when I was a painting contractor, and I had a passenger van that I modified by ripping out all the seats and even installing ladder racks on the roof, but I had an insurance policy like it was a station wagon. My agent saw me one day, and he said, "What, are you nuts? It's a commercial vehicle… if you get it an accident, the insurance company just won't cover you at all. In essence, you're paying premiums for no coverage."
Boy, was I a genius.
I tended to do the same thing with life insurance. I bought the cheapest term insurance I could buy with the strategy that I’d become self-insured someday. It took years before I realized that you get what you pay for, and that term insurance can end up being the most expensive insurance you can buy — next to being self-insured.
Needless to say, years later and wiser, I’ve done a complete 360° change in strategy.
So, How Do I Insure My Real Estate?
There's many ways one can insure their real estate from the time of purchase with things like renters'/homeowners' insurance, to title insurance and even home warranties.
Some of these protect the bank, and some protect us, but many that protect the bank can indirectly protect us, too. For example, in the event of a catastrophe, such as the house burning down, if your insurance company pays to rebuild the house or pays off the loan, this not only protects the bank's capital, but it also protects you from the liability of covering the cost.
As real estate investors, depending on skill sets and risk tolerance, we all have different preferred strategies for transferring risk and utilizing insurance. This could include everything from increasing coverage or riders to providing additional coverages for things like additions, private collections, disabilities, and loss of rents or use. You can almost insure against anything today, from major catastrophes like earthquakes and floods, to break-ins and fires.
Some strategies include increasing deductibles to lower premiums. Some of us lean towards being more self-insured by setting aside more reserves to handle that higher deductible or to have the cash on hand to take care of minor repairs, in turn making fewer claims.
Some of us may even carry an umbrella policy so as to increase our liability coverages. After all, the more you have, the more you have to lose.
Life Insurance As a Way to Protect Real Estate?
What I was really referring to in my last article was the ability to use more leverage to build more real estate wealth by utilizing life insurance.
I truly believe that it allows for more use of leverage by enabling us to decrease our risks. This, in turn, lets us be more productive. It gives us the peace of mind and confidence to utilize our assets in more productive ways without running the risk of losing everything.
Today, I even use life insurance as another investment bucket, and I use it as my own personal bank to do deals. Years ago, when I was still a painting contractor, I worked with a builder who taught me this strategy. He would borrow out of the cash value of his life insurance to build a house, flip it, and then pay back the policy loan, keeping the remainder of the profits.
There aren’t many loans that are easier to obtain than borrowing from your own policy.
Staying with this example, keeping money in a separate bucket (i.e. a life insurance policy) would protect the builder’s capital (in most states) from lawsuits and bankruptcy. The money in the policy builds tax-free, tax-deferred, and passes favorably to heirs.
If he passed, his family would have that money to pay off real estate properties if they wanted to, or maybe they would sell the properties and use the insurance money for something else. His heirs would have options.
Keep in mind — if you’re ineligible for life insurance, mortgage insurance may be a viable alternative to having no insurance. An example of this is my best friend growing up, who got terminal cancer when he was 36 years old, and he didn’t have life insurance. He did, however, qualify for mortgage insurance. When he passed, the mortgage insurance paid off the house that his wife and three kids still live in today.
Other Insurances to Consider
In another previous article, “3 Insurance Products You Probably Didn’t Know About – But Should Be Using,” I talked about crazy things like utilizing a “put” option on a real estate stock, like Pulte or Toll Brothers, to try to protect yourself against a major shift in the real estate market since most of us are so top-heavy with our real estate investments.
There are other insurances to consider that I use today, like Business Insurance and Workmen’s Comp. We can also insure real estate holdings and investments through things like the proper entity selections, titling, and groupings.
But the insurance that people disregard the most, which could help protect your real estate and family’s wealth, is Disability Insurance. A study by the Home Finance Agency of the United States government found that 48% of all foreclosures came from disability, while only 3% came from the death of a borrower. Approximately 50% of all bankruptcies and foreclosures come from the same form of disabilities. (See Press Release).
Long-term health care is another one to consider if you really want to protect your real estate portfolio for your heirs.
Now, I’m not advocating to overpay for insurance or to be over insured. But when I’m investing, I know that if I have enough disability insurance and life insurance, among other insurances, I don’t have to worry about my wife. It provides me with peace of mind, allowing me to leverage more and to continue building wealth.
To me, this is one of the best ways to become financially free, while at the same time keeping my tax deductions, with my tenants’ rent payments, buying properties for me and my family.
As you can see, there’s a lot that can go into protecting your real state and wealth in the best ways to pass on to your loved ones. My best advice to ensure this is to make sure that your whole team of advisors is on the same page when planning and utilizing strategies.
So, how do you insure your real estate?
Let’s talk in the comments section below!