You Should Buy More Insurance Than Your Mortgage Lender Requires. Here's Why

Having only the insurance your lender requires could leave you without important coverage.

As any homeowner knows, mortgage lenders have a number of requirements when closing on a loan.

One of the most important requirements is related to buying homeowners insurance. Homeowners insurance is mandatory not just at closing, but for the entire time a mortgage is taken out on the home. In fact, if a homeowner lets their coverage lapse, a lender can buy force-placed insurance to cover the property -- and this insurance comes at a high cost.

While homeowners must comply with their lender's mandated home insurance coverage rules, buying the protection that the lender requires often is not sufficient. In fact, most people would be better off if they buy more insurance coverage than the mandated amount. Here's why.

Why it's a good idea to buy more insurance coverage

Typically, a mortgage lender is only interested in making sure the dwelling is insured for enough to pay off the mortgage in the event that the house is destroyed. A lender does not care if the homeowner suffers uncompensated losses. It just wants to protect its interest in the collateral. As a result, lenders generally require the purchase of dwelling coverage for a set amount of money, but may not impose any additional requirements.

Homeowners, however, should get enough insurance to provide full protection for their assets -- and that means buying coverage for more than just the building itself.

Typically, homeowners should buy personal property insurance so the contents of their house are covered. Otherwise, they might be forced to pay out of pocket to cover all of their personal possessions if something went wrong.

Buying a substantial amount of liability coverage is also a good idea. This type of policy pays out if someone is hurt on the property. Without it, a homeowner could be held responsible for paying for losses out-of-pocket if someone got injured while visiting.

Other coverage, such as loss of use coverage, could be important as well. This would pay the homeowner's additional expenses if they had to move out of the home temporarily because it was being restored or rebuilt after a covered loss occurred.

How to decide how much home insurance is needed

Ultimately, it's important for every homeowner to make sure they have the coverage their mortgage lender requires -- as well as coverage for other losses that could cause financial catastrophe.

Insurance is purchased in order to transfer risk. If a homeowner cannot afford to replace all their furniture, clothing, and electronics after a fire or couldn't pay out tens of thousands of dollars in medical bills after someone got hurt on the property, they should pay premiums to transfer the risk of bearing these losses to an insurance company.

Homeowners should consider the value of their property and their net worth when deciding the extent of coverage to buy. The more their property costs, and the more personal assets that could be at risk if they are sued, the more coverage they should buy. It's worth taking the time to think carefully about this, and perhaps even to talk with an insurance agent for help in determining the necessary amount of coverage, rather than just buying the minimum a lender asks for.