Insurance Requirements for Rental Property
Cleveland, OH · Member since 2019 · 114 posts · 40 votes
I’m a newbie so I think this question is appropriate. I’ve received different answers from different people so here it is. For rental properties ... do lenders require your insurance to cover replacement value of the structure or just a typical “landlord” policy? I have been told if you have a loan on your rental property you need to insure it for the replacement value.
However, my agent that I use for insurance on my primary residence is telling me that all his REI clients have a landlord policy that just covers their loan amount or the fair market value of the property. The market value is usually much less than the replacement cost so there's a big difference in premiums.
What my insurance agent is saying makes more sense because why would a bank require you to have coverage beyond the amount they are lending you? Obviously I will be checking with my bank and other lenders but I was just curious if anyone had a definitive answer.
Just to provide an update for anyone interested...
I connected with @Damon Rucker on a different thread and he was paying something like $210 per month for insurance. This is what started me on this subject because the few real estate investors I know are paying around $75 to $100 per month. So I contacted my agent to get a price quote for a deal I was analyzing. This particular property was quoted at $80 per month but relatively close to what I had heard from other people. Damon messaged me yesterday to tell me he contacted my agent and was pleased to find out that he could insure his property for much less than $210 per month. I also talked to another investor I work with yesterday. He has multiple properties with mortgages all insured for a little over what the ACV is. His properties are all duplexes valued between $60K and $100K and his insurance runs him about $75 per month.
I think how your insure your property is really up to you as an investor as long as the insurance covers any amount you may owe lenders. Of course I would want more insurance than what I owe on the property (at least market value plus 20%) but in my opinion replacement cost is not worth the premium. Especially when you are dealing with sub $125K properties built prior to 1960. The replacement cost could easily be double what the actual market value of your property is depending on when it was built. So when deciding to go with ACV or replacement cost coverage you really have to consider what you owe on the property, what the market value is, and how that compares to replacement cost. Just my opinion as a newbie.
Chris, I forgot to address this post in regards to ACV versus RC. Just want to add to your comments to make sure you know what your risks are with ACV.
The insurance carrier and claim payout has no relation to how much you owe the bank.
RC vs ACV example for the investor above could play out like this -
Building insured for $60k on ACV, has an $80,000 fire. There is not enough building damage for the property to be razed, so it needs to be fixed. 50% depreciation can apply if the building has not had major updates the last 20 years. In this case, you would have enough insurance limit to get your $40k, but still need to come to the table with the other $40k.
With a Replacement Cost policy, you would get $60k of the $80k claim. Still $20k out of pocket, but less than the $40k.
My main concern with investors taking on ACV is that their agent has not walked them through all of the claim examples for the investor to make an informed decision. Many times the additional risk with ACV is glossed over without putting pencil to paper and putting a true $ figure to what the loss could be.
Once you really know what is at risk, you may find that on a certain smaller property, $100 of premium savings is only $7k of additional risk, while on a larger building $300 of savings gives you $50k of risk.
I'd be interested to hear others responses to this. I recently went through this myself with State Farm and they told me it depends on the bank, but I believe State farm could only go as low as 75% of replacement value.
What do you mean by "typical landlord" policy (100% of replacement value)? What insurer are you using that will let you insure it at the loan value? Has the bank signed off on this?
@Brady Boyer
I just used my agents terminology but they call it a landlord policy. It has 3 levels of coverage. You set the dollar amount of coverage which would be your loan amount or market value or higher if you want. Tier three even covers loss of rent up to like $15k if it’s caused by flood or fire, etc. This makes sense to me. But there are other members on head that day differently so I haven’t really got a clear answer. I would imagine it might vary by lender. Here is something I found on a home guide website...
Landlord Coverage
Mortgage lenders want evidence that the borrower has sufficient coverage (at least equal to the mortgage loan amount) that protects the property itself against fire, wind, water damage or other named hazards that might decrease the value of the real estate. The lender also wants, but may not mandate, the borrower to have reasonable liability insurance coverage, should someone (or his personal or real property) be damaged through landlord neglect or inappropriate action. Protecting the real estate value up to the outstanding loan balance is the prime consideration, however.
General Rule Exceptions
While mortgage lenders require landlords to procure hazard insurance equal to the loan balance, there are occasional exceptions. For example, an owner who rents waterfront, particularly oceanfront, property that includes a small home on a large lot may find it impossible to buy insurance equal to the mortgage balance. The majority of the value may involve the desirability of the land, not the structure itself. An insurance company will not issue coverage vastly exceeding the value of the structures. Another exception often occurs with condominiums. The master policy (covering all exteriors of structures) may only need landlord insurance that covers the interior walls, ceilings and floors of the condominium unit.
Considerations
Homeowners should consider two other issues. First, the difference between the mortgage balance and the fair market value (FMV) of the home equals the borrower's ownership level. This amount should also be insured. A total loss will protect only the mortgage lender, not the owner, if the coverage level is only equal to the loan balance. Second, the owner should also consider insuring against the loss of rent. The mortgage lender will not mandate this coverage, but will be pleased if it exists. The homeowner will be even more pleased if long-term or hazard loss vacancies occur, offering no cash flow to make mortgage payments.
@Brady Boyer
Farmers Insurance. I have not checked with the bank. I'm preparing to make my first offer once my financing clears and I clarify some things. This being one of them. I'm going to call my bank tomorrow and find out what their policy is. I guess it's possible it varies by lender and insurance company. I'm also going to check with a couple local REI's I know. I know that their properties have mortgages and their insurance is around $80 per month. I just have never asked them what type of coverage they have. These properties were probably purchased in the $60k to $80k range. So this lined up with what my agent was saying. The landlord policy he quoted was $80 for $150k in coverage but if I wanted replacement cost coverage it'd be $200 per month. Cash flow killer if you don't know which one you need when analyzing deals.
Let me know what you find out
@Tyler Speelman
Thank you! That makes sense to me. And basically what my insurance agent said. I was just getting mixed information from others in the forum.
Here's the reason you should consider having full replacement cost coverage:
Let's say I have a property in a decent area, but just the lot itself is not highly marketable (very often the case in a B/C neighborhood). If I have just enough coverage to pay off the mortgage, but not enough to rebuild the home, I'm left with a lot and I lose the cash flow that the property was generating. Is that the scenario you would like to end up with?
I personally would not get insurance just for the loan amount. I would use the market value plus say 15% or 20% as long as this was more than the loan amount which it should be. Plus if something did happen then you'd likely have some equity built by that point. For simple math lets say you bought for a house for $100K and put $20K down and we'll assume this covers closing costs and all that just to keep it less confusing. Let's even assume the market value is $100K. So you have an $80K loan and $20K in equity (down payment). You insure the property for $120K (20% more that market). It burns to the ground and you are left with a lot. Well you get $120K in insurance money and pay your loan of $80K off and put $40K in your pocket. That is $20K more than what you started with and now you have a free lot (land). Perhaps the land isn't worth much but it isn't worthless. Yes you lost your cash flow but you also made a profit and at a pretty good rate of return. I know this is oversimplified because you would have deductibles and other costs through the process but you get the concept. I guess it all depends on the individual and the property you are insuring. Is paying twice the amount for insurance and losing cash flow worth having replacement cost insurance? Perhaps in A & B class neighborhoods. Probably not in C class or lower. Again it probably really just depends on the location, the property, and the individual investor.
We use Foremost, DP3 with full replacement value and loss of rents, it’s not much more expensive than cash value. It was more than enough insurance coverage for our mortgage company.
@Chris Taylor i agree with what has been said above. mortgage companies just care about protecting their investment not the full property value. Now I do advise my customers to insure the full replacement value so that if a fire or anything else does wipe out the house you can actually rebuild it, but its up to you whether you want coverage to rebuild or just enough coverage to protect what you bought it for.
Thanks for the information guys. I am seeing there is some flexibility on what you can do. In the deal I was analyzing it was a purchase price of $125K and I got a quote for $150K in coverage which included loss of rent up to $15K. The replacement value of the property was like $350K if I remember correctly. Which took the premium from $80 per month to $200 per month. A pretty big spread so I guess you better know which you are doing beforehand when you are analyzing the deal.
Also, keep in mind that many insurance companies do not offer replacement cost if you insure below 80% of replacement cost. Therefore, if you have a non total loss, you will not be reimbursed for the full cost of repairs, but they will be depreciated. Make sure when you choose your coverage that you do have replacement cost, or you could be out of pocket a good bit.
Just to provide an update for anyone interested...
I connected with @Damon Rucker on a different thread and he was paying something like $210 per month for insurance. This is what started me on this subject because the few real estate investors I know are paying around $75 to $100 per month. So I contacted my agent to get a price quote for a deal I was analyzing. This particular property was quoted at $80 per month but relatively close to what I had heard from other people. Damon messaged me yesterday to tell me he contacted my agent and was pleased to find out that he could insure his property for much less than $210 per month. I also talked to another investor I work with yesterday. He has multiple properties with mortgages all insured for a little over what the ACV is. His properties are all duplexes valued between $60K and $100K and his insurance runs him about $75 per month.
I think how your insure your property is really up to you as an investor as long as the insurance covers any amount you may owe lenders. Of course I would want more insurance than what I owe on the property (at least market value plus 20%) but in my opinion replacement cost is not worth the premium. Especially when you are dealing with sub $125K properties built prior to 1960. The replacement cost could easily be double what the actual market value of your property is depending on when it was built. So when deciding to go with ACV or replacement cost coverage you really have to consider what you owe on the property, what the market value is, and how that compares to replacement cost. Just my opinion as a newbie.
I will contact my agent to clarify. But based on my initial conversation with him and the written quote he sent me, the landlord policy he quoted covered any loss up to the insured amount. In this case I had him quote $150K of coverage as the asking price for the property was $125K. Obviously if I ended up offering on the property, I would have it appraised and base my coverage on that amount plus 20%. I talked this through with my agent because the replacement value of the building was something like $350K. Wouldn't $350K be over insured? My agent seemed to think so because he said I'd be crazy to insure at that kind of replacement cost for a rental property. He also said out of the 30 landlord policies he has that none of them are insured at replacement cost.
@Bob B.
Just spoke with my agent. If you have $150k in coverage you are insured up to that amount regardless if it is a partial loss or total loss. Surcharges are added to your premium based on the number of units. The more units the higher your premium. These surcharges are meant to account for properties with multiple units. So no matter what happens you are covered up to the insured amount. In this case $150k.
Now if the building catches fire and 3 of the 4 units are destroyed I would be covered up to $150k. If the cost to rebuild those 3 units is more than $150k then I would gladly take my 20% profit (remember I bought the property for $125k) sell the burned property as is, and walk away with a nice return on my money.
Side note: this coverage also covers up to $15k in lost rent which is also adjustable based on your preference.
BiggerPockets actually did a podcast on this subject so it surprises me there is so much difference of opinion on this topic.
@Bob B.
Just spoke with my agent. If you have $150k in coverage you are insured up to that amount regardless if it is a partial loss or total loss. Surcharges are added to your premium based on the number of units. The more units the higher your premium. These surcharges are meant to account for properties with multiple units. So no matter what happens you are covered up to the insured amount. In this case $150k.
Now if the building catches fire and 3 of the 4 units are destroyed I would be covered up to $150k. If the cost to rebuild those 3 units is more than $150k then I would gladly take my 20% profit (remember I bought the property for $125k) sell the burned property as is, and walk away with a nice return on my money.
Side note: this coverage also covers up to $15k in lost rent which is also adjustable based on your preference.
BiggerPockets actually did a podcast on this subject so it surprises me there is so much difference of opinion on this topic.
Chris, I commend you on your research into this area. Insurance is confusing as there are so many variables and decisions contingent on an investors risk tolerance, portfolio and market location.
I urge anyone to ask their agent how their policy will reach to some of these claim examples because all policies are not uniform in coverage and all state insurance laws are not the same.
Based on all of the above comments, keep these items in mind;
- Some insurance policies will have a Coinsurance clause, which will penalize you for insuring for less than the Replacement Cost. This is almost always the case with a commercial policy. Not as common when insuring 1-2 unit rentals.
- Some states, like OH, will pay the "Stated Value" that the building is being insured for. $150k in your example above. Other states will only pay the appraised value of the property at the time of the total loss, in your case above, $125k.
- The city will determine if you can knock down your property and walk away, not the insurance company. What happens if the city requires you to rebuild a property that will take $200k to repair and you are only insured for $150k?
Hope that helps add to the undersratnding of some of the additional things that need to be considered when choosing coverage limits.
@Jason Bott
Thank you very much! It definitely helps. Especially the last point about the City requirement. I would have never guessed that would be a factor.
Just to provide an update for anyone interested...
I connected with @Damon Rucker on a different thread and he was paying something like $210 per month for insurance. This is what started me on this subject because the few real estate investors I know are paying around $75 to $100 per month. So I contacted my agent to get a price quote for a deal I was analyzing. This particular property was quoted at $80 per month but relatively close to what I had heard from other people. Damon messaged me yesterday to tell me he contacted my agent and was pleased to find out that he could insure his property for much less than $210 per month. I also talked to another investor I work with yesterday. He has multiple properties with mortgages all insured for a little over what the ACV is. His properties are all duplexes valued between $60K and $100K and his insurance runs him about $75 per month.
I think how your insure your property is really up to you as an investor as long as the insurance covers any amount you may owe lenders. Of course I would want more insurance than what I owe on the property (at least market value plus 20%) but in my opinion replacement cost is not worth the premium. Especially when you are dealing with sub $125K properties built prior to 1960. The replacement cost could easily be double what the actual market value of your property is depending on when it was built. So when deciding to go with ACV or replacement cost coverage you really have to consider what you owe on the property, what the market value is, and how that compares to replacement cost. Just my opinion as a newbie.
Chris, I forgot to address this post in regards to ACV versus RC. Just want to add to your comments to make sure you know what your risks are with ACV.
The insurance carrier and claim payout has no relation to how much you owe the bank.
RC vs ACV example for the investor above could play out like this -
Building insured for $60k on ACV, has an $80,000 fire. There is not enough building damage for the property to be razed, so it needs to be fixed. 50% depreciation can apply if the building has not had major updates the last 20 years. In this case, you would have enough insurance limit to get your $40k, but still need to come to the table with the other $40k.
With a Replacement Cost policy, you would get $60k of the $80k claim. Still $20k out of pocket, but less than the $40k.
My main concern with investors taking on ACV is that their agent has not walked them through all of the claim examples for the investor to make an informed decision. Many times the additional risk with ACV is glossed over without putting pencil to paper and putting a true $ figure to what the loss could be.
Once you really know what is at risk, you may find that on a certain smaller property, $100 of premium savings is only $7k of additional risk, while on a larger building $300 of savings gives you $50k of risk.
@Chris Taylor. Good thread, maybe it does vary by the bank, I just haven’t come across one yet. I should also add typically the bank will want you to insure 80 percent of replacement value.
@Caleb Heimsoth
You are correct. It is going to vary by lender and also on your insured value compared to the replacement cost.
Lesson learned is that you should always be sure of what coverage you need because it could have a major impact on your cash flow.
@Chris Taylor
Lots of great info so far.. but you certainly sound educated enough to make the right decision for yourself.
Good luck
Just had a fire on my two unit building. 2nd floor unit burned out. The water damage caused by the fire department created even more damage. No fault of FD just a reality of fires.
Property was appraised for 160k. By Luck I insured it for 200k and had loss of rents. Damage is already at 130k plus code compliant updates that will be required. Electrical conduit (no romex here) plumbing updates, etc. You can insure for the cost of the mortgage, but in reality it probably won’t be enough. We’re all looking to keep our cost down,but for a few more dollars piece of mind is important as well. Require renters insurance as well. If tenant is responsible for the loss your insurance will go after there liability portion of their policy. It may save your behind.
Good Luck Everyone.
Thank you. Same to you.