You are not legally required to buy homeowners insurance, even if you have a home equity line of credit (HELOC) or a mortgage on your home. However, as a rule, lenders refuse to write loans secured by residential property unless the owner obtains homeowners insurance. Therefore, due to bank rules, rather than federal or state laws, you can only get a HELOC if you have homeowners insurance.
When you take out a HELOC, a bank provides you with access to a line of credit that you can use for a period of 10 or even 20 years. If you default on repaying the debt, the lender can foreclose on your home and sell your house to raise the money to pay off the debt. If you do not have homeowners insurance then you expose your lender to the risk that a fire or other calamity could destroy your home and leave the lender with an unsecured debt. Lenders require you buy insurance to prevent this from occurring.
When you take out a mortgage or a home equity loan, your lender requires you to buy sufficient insurance coverage to cover the outstanding balance of the loan. Insurance requirements for HELOCs work differently and are not based on the balance owed. Instead, you must obtain sufficient homeowners insurance to cover the HELOC line amount, rather than the balance you owe on the line. If you have a second lien HELOC, you must obtain enough insurance coverage to cover both the first mortgage and the HELOC line amount.
In addition to homeowners insurance, you also have to contend with flood insurance. The Federal Emergency Management Agency releases an annual report that identifies areas of the nation that are at a high risk of flooding. Under federal law, banks cannot issue HELOCs or home equity loans to people who live in these so-called special flood hazard areas, unless those homeowners buy flood insurance. Flood insurance specifically protects against losses due to water damage caused by floods, so having an existing homeowners insurance policy does not mean you do not have to buy a flood insurance policy.
If you own your home free and clear, you do not have to buy homeowners insurance, so the cost of buying it when you take out a HELOC may seem like an unnecessary and unwelcome expense. However, although the insurance protects your lender, it also protects you in the event that your home incurs major damages. Additionally, some states have laws that allow a lender to sue you for an unpaid balance on a home loan, even after foreclosing on your home. Having homeowners insurance protects you from monetary loss stemming from your lender foreclosing on your damaged home and suing you when the home sale proceeds fail to cover the amount of your debt.
- Federal Reserve Board; What You Should Know About Home Equity Lines of Credit; August 2009
- Harvest Insurance: California Homeowners Insurance
- State of Wisconsin Department of Financial Institutions: Industry Alert: Homeowners Insurance Policy Limits
- Federal Deposit Insurance Corporation: LOANS IN AREAS HAVING SPECIAL FLOOD HAZARDS