If you're buying a home and have never heard of force-placed insurance, beware: even if you've been making full and timely mortgage payments, you could be hit with huge property insurance charges. How high? Perhaps ten times what you should be paying.
What is "force-placed insurance" and how can you avoid getting snagged?
Let's start with a few mortgage basics. When you're buying a home with a mortgage, the loan is secured in two ways: First, you agree to repay the debt -- that's why lenders look so closely at credit scores and credit reports. Second, if the debt is not repaid, the lender can get back its money by foreclosing.
It follows that the lender wants to protect its interest in the property, and for this reason it requires you to maintain adequate homeowners insurance coverage for the life of the loan.
Buying a Home: Property Insurance
Getting homeowners insurance is not a problem, at least initially. The lender requires property insurance as a condition of the loan. Once you have coverage, the lender requires that you maintain the policy. If you borrow with less than 20 percent down, the lender will pay the insurance premium from the escrow money it collects each month as part of your mortgage payment.
At least that's how it's supposed to work.
Keep Up Your Premiums...Or Else!
The catch is that your mortgage is owned by your lender and its "successors and/or assigns." In other words, there's a good possibility that your loan will be sold and re-sold to mortgage investors. Your current lender and any subsequent lienholder monitor your account to make sure the required insurance coverage is in place. If not, they have the right to buy it for you and the policy they buy is called force-placed insurance.
"Force-placed insurance," according to New York's Department of Financial Services, "is insurance taken out by a bank, lender, or mortgage servicer when a borrower does not maintain the insurance required by the terms of the mortgage. This can occur if the homeowner allows their policy to lapse (often due to financial hardship), if the bank or mortgage servicer determines that the borrower does not have a sufficient amount of coverage, or if the homeowner is force-placed erroneously."
The lender has a huge incentive to get complete insurance coverage and that's entirely fair because the property is security for the mortgage and you agreed to get and keep a policy. However, the lender or loan servicer has no incentive to shop around for the lowest rate and that's where problems arise.
Force-Placed Insurance Overcharges
New York state found that "premiums charged to homeowners for force-placed insurance can be two to ten times higher than premiums for voluntary insurance -- despite the fact that force-placed insurance provides far less protection for homeowners than voluntary insurance."
This is like charging as much as $35 for a gallon of gas that can be purchased around the corner for less than $4.
Things get even stickier when a home is foreclosed. For instance, in 2012 Fannie Mae and Freddie Mac -- the folks who buy, sell and guarantee mortgages -- found that they had been stuck with force-placed insurance fees of $914 million. Of that amount, the Federal Housing Finance Agency's Inspector General estimated that the "combined financial harm amounted to $158 million" and recommended that Fannie Mae and Freddie sue to get back the alleged overcharges. If the insurers are overcharging Fannie and Freddie, it's a pretty safe bet they're overcharging homeowners.
Buying a Home and Protecting Your Interests
How can you avoid force-placed insurance when buying a home? Here are four steps to take.
1.Work with a competent insurance broker. You want a property insurance policy that fully protects your property for the lowest cost and you also want something else: You want an insurance broker who immediately and fully responds to your inquires and questions. This is important not only in case there's a claim but also if the possibility of force-placed insurance arises.
2. Beware of brief form letters from your lender or loan servicer asking about property insurance coverage. These are not friendly inquiries -- they should be seen as very-real mortgage compliance tests. You MUST respond. If you delay or do not respond you will be hit with force-placed insurance coverage.
3. Contact your insurance broker and have them get in touch directly with the lender or loan servicer on your behalf. This must be done immediately. The insurance broker will provide evidence of coverage and that should be the end of the issue. Make sure you receive copies of all correspondence between the insurance broker and the lender or loan servicer and keep such letters in your files.
4. Pay your insurance premiums. On time. If you have purchased property with at least 20 percent down, you can pay your hazard insurance premium directly. Don't abuse this privilege.
If you run into tough times, it may be tempting to make your mortgage payments but skip property insurance premiums. This is a no-no. You must pay your homeowners insurance; otherwise, you're violating the loan agreement and the lender has the right to obtain property insurance for you -- most-likely at a steeply-inflated cost.