Property or hazard insurance policies are designed to cover your losses if your home is damaged in a flood, fire or other event. You negotiate the terms of the coverage with your insurer, but your lender may get involved in those discussions if you refinance your home. The lender and the homeowner have an interest in protecting a financed property.
Many states have laws requiring you to insure cars and other vehicles, but you're not required by law to buy a hazard insurance policy on your home. However, if your home burns down, the collateral that secured your loan goes up in smoke. If you stop paying on the mortgage, your lender is unlikely to recoup its losses by selling a charred patch of land. Therefore, lenders usually require you to have homeowner's insurance before you take out a mortgage. If you let the insurance policy lapse, your lender will buy a policy on your behalf and add the cost to your loan amount.
Most lenders require you have enough insurance coverage in place to cover the balance of your loan. If your house burns down, the insurance proceeds go to your lender and you only get any money if the coverage amount exceeds the loan balance. You can use a cash-out refinance loan to pay off your existing mortgage and get additional funds to cover your other debts. However, many lenders will require you to increase your coverage to cover the balance of the new loan.
When you take out a straight refinance loan, you simply pay off the existing loan with a new loan for the same amount. Your lender may not require you to increase your coverage when this occurs because your lender's interest in the property has not increased. Government-backed mortgage company Fannie Mae only requires homeowner's policies to insure the lesser of the property value and the loan amount. However, things can get complicated because some insurance firms sell policies based on the replacement cost of a home rather than the actual market value. Depending on the pricing method, your lender may require you to increase your coverage level.
The Federal Emergency Management Agency produces an annual report detailing areas of the nation that are in high-risk flood zones. Over time, weather patterns and water levels change. Your home may not have been in a flood zone when you bought it, but it may fall into one now. Legally, a lender cannot write a loan or increase a loan amount on a property in a flood zone unless the homeowner has bought a flood insurance policy. Often, the flood zone issue comes to light only when people try to refinance their homes.