Why Do Mortgage Lenders Require Homeowners Insurance?

If you want to borrow for a home, you'll need a homeowners policy.

There are different steps you'll need to take on the road to getting a mortgage. These include providing your lender with financial documents, including pay stubs and recent tax returns, as well as going through the home inspection process.

You'll also need to put homeowners insurance in place before closing on a mortgage. And to be clear, that's not just to protect you -- it's a requirement imposed by lenders.

Why so? The answer is simple.

Lenders need to protect themselves

Technically, you don't need a homeowners insurance policy to buy a home. But if you're financing a home purchase with a mortgage, as opposed to buying a property outright with cash, then you'll need homeowners insurance to finalize that home loan.

When mortgage lenders give out home loans, they take a risk -- that they won't be repaid. This is why borrowers with higher credit scores tend to snag lower mortgage rates than those with poor credit. Higher credit means you're less of a risky borrower in the eyes of lenders.

Now if you fall too far behind on your mortgage payments, the only recourse your lender might have to get its money back at that point is to force the sale of your home via a process known as foreclosure. But if your home is damaged or destroyed, your lender won't have a property to sell in that situation.

That's why mortgage lenders require home buyers to purchase homeowners insurance. If your home is destroyed and you have insurance in place, your home can be rebuilt. Without insurance, both you and your lender may be out of luck.

How much homeowners insurance do lenders require?

Generally, mortgage lenders will require that borrowers get a homeowners insurance policy that covers 100% of their homes' replacement cost. That way, a home can be rebuilt in the event that it's completely destroyed. The cost of an associated policy based on that requirement will depend on where you live and the size and features of your home.

What if you're not getting a mortgage?

Even if you're able to buy a home in cash and therefore aren't required to get homeowners insurance, it's an unwise idea to forgo that coverage. If your home is destroyed by a fire or weather event, you could be out hundreds of thousands of dollars if it needs to be rebuilt from the ground up.

Plus, homeowners insurance protects you in the event that someone gets injured on your property. Let's say a delivery person comes to your door to drop off a package and slips on an icy patch along your walkway. That person could file a lawsuit against you to cover their medical bills -- but a homeowners insurance policy will generally pick up that tab.

Now this isn't to say you shouldn't try to save money in the course of procuring homeowners insurance, and you can do so by shopping around with different insurance companies for the best rates. But regardless of whether you're getting a mortgage, it pays to put homeowners insurance in place. After all, if lenders insist on it to protect their financial interests, you should be invested in protecting yours.